The division managers of Chester Construction Corporation submit capital investment proposals each year for evaluation at the corporate level. Typically, the total dollar amount requested by the divisional managers far exceeds the company’s capital investment budget. Thus, each proposal is first ranked by its estimated net present value as a primary screening criterion. Jeff Hensel, the manager of Chester’s commercial construction division, often overstates the projected cash flows associated with his proposals, and thereby inflates their net present values. He does so because, in his words, “Everybody else is doing it.”
a. Assume that all the division managers do overstate cash flow projections in their proposals.
What would you do if you were recently promoted to division manager and had to compete for funding under these circumstances?
b. What controls might be implemented to discourage the routine overstatement of capital budgeting estimates by the division managers?