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What is the significance of judgment in Capital Budgeting decisions?
Due to the importance of qualitative factors, judgment plays a significant role in capital budgeting. Judgment may seem to be a matter of fancy to many, but its roots are strongly planted in the facts. Decision-making is no different; it must rely on judgment most of the time when it decides something for the organization.
There have been debates about the efficiency of judgment in making the right choices in an investment evaluation process. However, many renowned economists have accepted the fact that judgment is an unavoidable tool to make the right business decisions in the case of capital budgeting.
The role of judgement is subject to the following typical responses in the capital budgeting process −
Judgment of the future− The visions of the judgment of the future play a critical role in the capital budgeting decision-making process. Factors such as a change in government policy, market potential, possibilities of technology change, etc., are all part of a vision of future judgment that is unavoidable in the capital budgeting process.
Taking crucial management decisions− Judgement is an inseparable part of managerial decision-making. Cost and benefit analysis, cash flow forecasting, evaluation of investment, pros and cons of an investment decision, are all essential parts of the judgment that play a major role in capital budgeting.
Judgment in case of mutually exclusive projects− Judgment must be utilized in case of mutually exclusive projects or projects that seem to offer the same benefits in the long run. In the long-term future of businesses, stress must be provided on judgment to decide the most profitable projects. However, for routine projects, liquidity and profits should be preferred over judgment.
With the association of quantitative methods, judgment can be a comprehensive tool to determine the reliability of figures. Judgment of how much and when should be remembered by financial decision-makers all the time when they make business decisions. That is, judgment can prove how appropriate a financial fact or figure is when it is matched with the first few cases of responses.
What is known as the intuition of informed judgment is a powerful tool for business owners. In fact, people use intuition or judgment more often than actually realized. It is a matter of self-decision-making that pays rich dividends in most of the business cases. In other words, businessmen act more intelligently than what they talk about.
However, over-dependence on just intuition can also be problematic. In some business calculations, quantitative measures are unavoidable and, in such circumstances, using just judgment could be detrimental for the firm.
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