Cost Allocation for Capital Budgeting Decisions

49 Pages Posted: 19 Oct 2006

See all articles by Tim Baldenius

Tim Baldenius

Columbia Buiness School

Sunil Dutta

University of California, Berkeley - Haas School of Business

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: September 2006

Abstract

Investment decisions frequently require coordination across multiple divisions of a firm. This paper explores a class of capital budgeting mechanisms in which the divisions issue reports regarding the anticipated profitability of proposed projects. To hold the divisions accountable for their reports, the central office ties the project acceptance decision to a system of cost allocations comprised of depreciation and capital charges. If the proposed project concerns a common asset that benefits multiple divisions, our analysis derives a sharing rule for dividing the asset among the users. Capital charges are based on a hurdle rate determined by the divisional reports. We find that this hurdle rate deviates from the firm's cost of capital in a manner that depends crucially on whether the coordination problem is one of implementing a common asset or choosing among multiple competing projects. We also find that more severe divisional agency problems will increase the hurdle rate for common assets, yet this is generally not true for competing projects.

Keywords: capital budgeting, hurdle rates, decentralization, agency problems

JEL Classification: D82, G31, M41, M40, M46

Suggested Citation

Baldenius, Tim and Dutta, Sunil and Reichelstein, Stefan J., Cost Allocation for Capital Budgeting Decisions (September 2006). Available at SSRN: https://ssrn.com/abstract=938509 or http://dx.doi.org/10.2139/ssrn.938509

Tim Baldenius (Contact Author)

Columbia Buiness School ( email )

3022 Broadway
New York, NY 10027
United States

Sunil Dutta

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-643-1229 (Phone)
510-643-1412 (Fax)

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-736-1129 (Phone)
650-725-7979 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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