Product Market Competitions, Capital Market Conditions And Capital Budgeting

Traditional capital budgeting methodologies are always subject to theoretical assumptions such as independency, exclusiveness, static competitive environment and etc, which are whereas very difficult to be satisfied. In another word, the demanding perfect information environment hardly exists in real business world and financial market.As far as product market is concerned, firstly the competitive landscape is always changing dynamically and information is always uncertain or inadequate. In competitive industries, companies could hardly sustain some sort of competitive advantage all along. The fast-changing competitive landscape and responses from competitors become major uncertain issues when companies are trying to make investment decisions. Accordingly, modeling those key factors into capital budgeting process is very necessary. In monopoly or oligopoly industries, the relationship among major competitors can be well understood by means of game theory. Secondly, companies are always facing inadequate information environment. It is sometimes and somehow very hard for decision makers to possess enough information for projections and related analysis. For example, it is always not easy to get relatively accurate market projections for some new products or technologies. Under those circumstances, simple probability weighted scenario analysis is meaningless. But introducing multi-stage evaluation and control ideas are very helpful. As far as capital market is concerned, traditional capital budgeting system implies efficient assumption, and thus no information asymmetry could exist between capital market and companies. However, information asymmetry could actually exist during certain periods or within certain sectors, which leads to market valuation cycles. On one hand valuation cycles have significant influence on the way external investments are made. On another hand, during those cycles, valuation criteria may be significantly different for short term and long term. If companies could not take into account those factors, those companies could be negatively evaluated, and thus damage those firms' financing ability and business operations. To solve information asymmetry issue in M&A, we will introduce payment and contract design into capital budgeting. To eliminate the negative impact brought by valuation cycles, we will introduce overall and cash flow portfolio management into capital budgeting process. This article adopts theoretical reasoning and case analysis as research methodologies. Firstly traditional capital budgeting methods and related assumptions, flaws in theories and applications are reviewed. Then existing amendment theories and models are introduced. Secondly capital budgeting models under three main situations of imperfect information are discussed. Thirdly some cases for all the models discussed in the previous part are analyzed. Finally, conclusion of the research is reached.