Introduction to Finance

LO 17.10 
The fi fth step of the capital budgeting process is the 
follow-up, or audit stage. Here, management estimates of cash fl ows 
are compared to the project’s actual cash fl ows. The fi rm should have 
processes in place to track projected and actual cash fl ows, determine 
causes of variations between them, and learn from their forecasting 
errors in an eff ort to improve the capital budgeting process. Managers 
should be held responsible if their estimates prove to be consistently 
infl ated, project after project. A project whose cash fl ows are well 
under budget should be considered for termination—better to stop 
future underperformance than allow it to continue to drain the fi rm’s 
resources.
LO 17.11 
As with fi nancial market investments, corporate invest-
ments should include risk/expected return considerations. Higher-risk 
projects should be evaluated using higher discount rates. One means 
of doing so is to use risk-adjusted discount rates where products in 
diff erent risk categories are assigned a discount rate based upon the 
fi rm’s cost of capital and the risk of the project.
The next chapter will examine how fi rms can estimate their cost 
of capital. This is important, as the cost of fi nancing the fi rm will be 
used as the discount rate for evaluating average risk capital budgeting 
projects.
Key Terms
base case
benefi t/cost ratio 
cannibalization
capital budgeting
cost of capital
depreciation tax 
shield
development stage
enhancement
follow-up stage
identifi cation stage
implementation stage
incremental cash fl ows
independent projects
internal rate of return (IRR) 
method
mission, objectives, goals, and 
strategies (MOGS)
modifi ed internal rate of return 
(MIRR)
mutually exclusive projects
net present value 
(NPV)
NPV profi le
opportunity cost
payback period method
profi tability index (PI)
risk-adjusted discount rate 
(RADR)
selection stage
stand-alone principle
strengths, weaknesses, 
opportunities, and threats 
(SWOT) analysis
sunk cost
Review Questions