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Capital Budgeting Methods and Consequences for Organizations

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The capital budgeting examples presented by Hunter et al. (1988) yield very high values. For an example in which reliance on validity generalization reduces the original cost of validating the selection predictor, Hunter et al. estimated a profitability index (PI) of 79, 741% and a payback period of one week. Before commenting on the implications of these results, we must point out that Hunter et al. reported an incorrect PI value in their example. The PI is the ratio of the present value of net cash inflows to cash outflows and is interpreted as the project's profitability for each dollar invested (Clark, Hindelang, & Pritchard, 1979; Weston & Brigham, 1981).

Therefore, the correct estimate of the PI is 797.41. However, this calculation error does not materially affect Hunter et al. 's argument about the magnitude of capital budgeting estimates of utility. Hunter et al. (1988) further suggested that capital budgeting estimates of utility might not be credible to managers because of their extreme magnitude; by doing so, Hunter et al. implied that these estimates should not be reported. However, as Boudreau (in press) noted, some capital budgeting indices (such as discounted net benefits) will produce lower utility values than will simpler indices, such as dollar value of the increase in output resulting from a human resource program.

Even when capital budgeting indices yield extreme values, they are a valuable source of utility information, particularly because they offer a standard basis for comparison with nonpersonnel investments. Rather than trying to avoid dealing with the issue of extreme utility estimates, we recommend that psychologists put more work into understanding why these estimates are so extreme.

Many capital budgeting estimates of the utility of human resource interventions (such as return on investment) will still greatly exceed estimates for other investments because investments in human resources involve a much higher degree of financial leverage than do typical investments in plant or equipment. That is, investments in human resources are often trivially small compared with the returns realized from those investments.

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