SAN SEBASTIAN COLLEGE RECOLETOS de CAVITE

GRADUATE SCHOOL DEPARTMENT

MASTER in BUSINESS ADMINISTRATION
MBA
3rd Trimester SY 2017-2018

DEMAND FORECASTING

MANECO –MANEGERIAL ECONOMICS

SUBMITTED BY:

GILO, SHERIDANNE P.

SUBMITTED TO:

ENGR. SHIELLA MARIE P. GARCIA

 DEMAND
FORECASTING
OVERVIEW

Demand forecasting is the area of predictive analytics dedicated to understanding consumer

demand for goods or services. That understanding is harnessed and used to forecast consumer

demand. Knowledge of how demand will fluctuate enables the supplier to keep the right amount

of stock on hand. If demand is underestimated, sales can be lost due to the lack of supply of

goods. If demand is overestimated, the supplier is left with a surplus that can also be a financial

drain. Understanding demand makes a company more competitive in the marketplace.

Understanding demand and the ability to accurately predict it is imperative for efficient

manufacturers, suppliers, and retailers. To be able to meet consumers’ needs, appropriate

forecasting models are vital.

 I. INTRODUCTION

An organization faces several internal and external risks, such as high competition,

failure of technology, labor unrest, inflation, recession, and change in government laws.

Therefore, most of the business decisions of an organization are made under the

conditions of risk and uncertainty.

An organization can lessen the adverse effects of risks by determining the demand or

sales prospects for its products and services in future. Demand forecasting is a systematic

process that involves anticipating the demand for the product and services of an organization in

future under a set of uncontrollable and competitive forces.

Forecasting provides an estimate of future demand and the basis for planning and sound

business decisions. Since all organizations deal with an unknown future, some error between a

forecast and actual demand is to be expected. Thus, the goal of a good forecasting technique is to

minimize the deviation between actual demand and forecast. Since a forecast is a prediction of

the future, factors that influence demand, the impact of these factors, and whether these factors

will continue influence future demands must be considered in developing an accurate forecast. In

addition, buyers and sellers should share all relevant information to generate a single consensus

forecast so that the correct decision on the supply and demand can be made. The benefits of a

better forecast are lower inventories, reduce stock outs, smoother production plans, reduced costs

and improved customer service.

 DEMAND FORECASTING

Demand Forecasting is a systematic process of predicting the future demand for a firm’s

product. Simply, estimating the potential demand for a product in the future is called as demand

forecasting.

According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a

process of finding values for demand in future time periods.”

In the words “Demand forecasting is an estimate of sales during a specified future period

based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”

Demand forecasting enables an organization to take various business decisions, such as

planning the production process, purchasing raw materials, managing funds, and deciding the

price of the product. An organization can forecast demand by making own estimates called guess

estimate or taking the help of specialized consultants or market research agencies.

PURPOSE OF DEMAND FORECASTING

The purpose of demand forecasting and estimation is to find a business's potential

demand so managers can make accurate decisions about pricing, business growth and market

potential. Managers base pricing on demand trends in the market. For example, if the market

demand for pizza is high in a city but there are few competitors, managers know they can price

pizzas higher than if the demand was lower. Established businesses use demand forecasting and
estimation if they consider entering a new market. If the demand for their product is currently

low, but will increase in the future, they will wait to enter the market.

SIGNIFICANCE OF DEMAND FORECASTING

Demand plays a crucial role in the management of every business. It helps an

organization to reduce risks involved in business activities and make important business

decisions. Apart from this, demand forecasting provides an insight into the organization’s capital

investment and expansion decisions.

The significance of demand forecasting is shown in the following points:

1. Fulfilling objectives:

Implies that every business unit starts with certain pre-decided objectives. Demand

forecasting helps in fulfilling these objectives. An organization estimates the current demand for

its products and services in the market and move forward to achieve the set goals.

For example, an organization has set a target of selling 50, 000 units of its products. In

such a case, the organization would perform demand forecasting for its products. If the demand

for the organization’s products is low, the organization would take corrective actions, so that the

set objective can be achieved.

2. Preparing the budget

Plays a crucial role in making budget by estimating costs and expected revenues. For

instance, an organization has forecasted that the demand for its product, which is priced at P10,
would be 100,000 units. In such a case, the total expected revenue would be 10* 100,000 =

P1,000,000. In this way, demand forecasting enables organizations to prepare their budget.

3. Stabilizing employment and production

Helps an organization to control its production and recruitment activities. Producing

according to the forecasted demand of products helps in avoiding the wastage of the resources of

an organization. This further helps an organization to hire human resource according to

requirement. For example, if an organization expects a rise in the demand for its products, it may

opt for extra labor to fulfill the increased demand.

4. Expanding organizations

Implies that demand forecasting helps in deciding about the expansion of the business of

the organization. If the expected demand for products is higher, then the organization may plan

to expand further. On the other hand, if the demand for products is expected to fall, the

organization may cut down the investment in the business.

5. Taking Management Decisions

Helps in making critical decisions, such as deciding the plant capacity, determining the

requirement of raw material, and ensuring the availability of labor and capital.
6. Evaluating Performance

Helps in making corrections. For example, if the demand for an organization’s products

is less, it may take corrective actions and improve the level of demand by enhancing the quality

of its products or spending more on advertisements.

KEY FEATURES OF DEMAND FORECASTING

Here are some of the main features of demand forecasting:

 Generate a statistical baseline forecast that is based on historical data.

 Use a dynamic set of forecast dimensions.

 Visualize demand trends, confidence intervals, and adjustments of the forecast.

 Authorize the adjusted forecast to be used in planning processes.

 Create measurements of forecast accuracy.

STEPS IN DEMAND FORECASTING

1. Specifying the Objective

The objective for which the demand forecasting is to be done must be clearly specified.

The objective may be defined in terms of; long-term or short-term demand, the whole or only the

segment of a market for a firm’s product, overall demand for a product or only for a firm’s own

product, firm’s overall market share in the industry, etc. The objective of the demand must be
determined before the process of demand forecasting begins as it will give direction to the whole

research.

2. Determining the Time Perspective

On the basis of the objective set, the demand forecast can either be for a short-period, say

for the next 2-3 year or a long period. While forecasting demand for a short period (2-3 years),

many determinants of demand can be assumed to remain constant or do not change significantly.

While in the long run, the determinants of demand may change significantly. Thus, it is essential

to define the time perspective, i.e., the time duration for which the demand is to be forecasted.

3. Making a Choice of Method for Demand Forecasting

Once the objective is set and the time perspective has been specified the method for performing

the forecast is selected. There are several methods of demand forecasting falling under two

categories; survey methods and statistical methods.

4. Collection of Data and Data Adjustment

Once the method is decided upon, the next step is to collect the required data either

primary or secondary or both. The primary data are the first-hand data which has never been

collected before. While the secondary data are the data already available. Often, data required is

not available and hence the data are to be adjusted, even manipulated, if necessary with a

purpose to build a data consistent with the data required.

5. Estimation and Interpretation of Results

Once the required data are collected and the demand forecasting method is finalized, the

final step is to estimate the demand for the predefined years of the period. Usually, the estimates

appear in the form of equations, and the result is interpreted and presented in the easy and usable

form.

TYPES OF FORECASTING

From the point of view of “time span”, forecasting may be classified into two:

1. Short-term Demand Forecasting

This is limited to short period not exceeding one year. It concerns with policies relating to

sales, purchases, pricing and finances. It is with reference to the existing production capacity of

the firm.

Short-term demand forecasting is useful in taking adhoc decisions concerning the day-to-

day working of the concern. Many companies use forecasting for setting sales targets and for

establishing controls and incentives. Knowledge of the short-term forecasting helps in short-term

planning.
2. Long-term forecasting

Long-term forecasting involves the assessment of long term demand for the product and

involves expansion of production units. A multi-product firm must ascertain not only the total

demand situation, but also the demand for different items.

Long-term forecasting involves the study of technological developments, economic

trends and consumer preferences and man-power planning, Long-term forecasting enables to

take major strategic business decisions.

When forecasts covering long periods are made, the probability of error may be high.

Hence, quality and competent forecasting are essential requirements for this type.

Methods of Demand Forecasting

There are several methods of demand forecasting applied in terms of; the purpose of

forecasting, data required, data availability and the time frame within which the demand is to be

forecasted. Each method varies from one another and hence the forecaster must select that

method which best suits the requirement.

1. Survey Methods

Under the survey method, the consumers are contacted directly and are asked about their

intentions for a product and their future purchase plans. This method is often used when the

forecasting of a demand is to be done for a short period of time.

The survey method includes:

 Consumer Survey Method

- is one of the techniques of demand forecasting that involves direct interview of the

potential consumers.

 Opinion Poll Methods

- are used to collect opinions of those who possess the knowledge about the market, such

as sales representatives, professional marketing experts, sales executives and marketing

consultants.

2. Statistical Methods

The statistical methods are often used when the forecasting of demand is to be done for a

longer period. The statistical methods utilize the time-series (historical) and cross-sectional data

to estimate the long-term demand for a product.

The statistical methods include:

 Trend Projection Method

 -is the most classical method of business forecasting, which is concerned with the

movement of variables through time. This method requires a long time-series data.

 Barometric Method

Barometric method of Forecasting was developed to forecast the trend in the overall

economic activities. This method can nevertheless be used in forecasting the demand

prospects, not necessarily the actual quantity expected to be demanded.

 The Econometric Methods

Econometric method make use of statistical tools and economic theories in

combination to estimate the economic variables and to forecast the intended variables.

TYPES OF FORECASTING METHOD

Qualitative methods

These types of forecasting methods are based on judgments, opinions, intuition, emotions, or

personal experiences and are subjective in nature. They do not rely on any rigorous mathematical

computations.
Quantitative methods

These types of forecasting methods are based on mathematical (quantitative) models, and are

objective in nature. They rely heavily on mathematical computations.

Market

System & Equilibrium

In economics, a market refers to the collective activity of buyers and sellers for a particular

product or service.

The Economic Systems

Economic market system is a set of institutions for allocating resources and making

choices to satisfy human wants. In a market system, the forces and interaction of supply and

demand for each commodity determines what and how much to produce.

In price system, the combination is based on least combination method. This method

maximizes the profit and reduces the cost. Thus firms using least combination method can lower

the cost and make profit. Resources are allocated by planning. In a market economy, goods are

allocated according to the decisions of producers and consumers.

 Resource allocation is the assignment of resources to specific tasks to determine the basic

economic choices, which are what to produce, how to produce, and for whom to produce for.

What and how much will be produced?

In a market system the forces and interaction of supply and demand for each commodity

determines what and how much to produce. Prices are the reflection of the scarce resource.

How will be produced?

The problem is what combination or mix of productive resources or inputs should be used in

order to produce a desired product. That is to use more labor and less capital or vice versa, to

more skilled labor and less units of unskilled labor or vice versa. In a price system, the

combination or mix of inputs should be based on least-combination method. This method

maximizes the profit and minimizes the cost. In other words, the least-cost combination is the

level of input use that produces a given level of output at minimum cost. On the other hand, in a

price system, competition will force firms to use the least cost combination method. Competition

means there are large numbers of buyers and sellers in each market that are acting independently.

Therefore, those firms that use the least cost combination method will be able to lower the price

of their products and make a profit.

For whom it will be produced?

The distribution of goods and services depends on the distribution of money income. Money

income, in turn, depends on the quantity, quality and the types of resources and the prices of the

product. Therefore, the distribution of finished goods and services will depend on consumers
ability and willingness to pay the market price. In fact, relative prices ration the available

resources, goods and services.

Resources may be allocated by tradition, by markets, or by planning. In a traditional

economy, goods and resources are allocated according to historical patterns. However, in a

market economy, goods and resources are allocated according to the decisions of individual

producers and consumers.

In a Planning economy, goods and resources are allocated according to the central

directions of a government agency.

1. Pure Capitalism is an economic system in which individuals own productive resources, and

those individuals can use resources in whatever manner they choose, subject to common

productive legal restrictions. In other words, it is the private ownership of productive resources

including labor and the use of market mechanism and prices to coordinate economic activities.

This system concerns the three Ps, prices, profits, and private property.

2. The Command Economy (Communism) is a system in which workers are motivated to

contribute to the community interest rather than working to promote self-interest. It is a system

where government mostly decides what and how much to produce how it will be produced, and

who will get them. That is by public ownership of all property resources and economic decision

making process through centrally planned economy

3. Mixed Economy (Welfare Capitalism) is an economic system in which decisions about how

resources should be used are actually made partly private sector and partly by public sector. It is

a system where most wealth is generated by businesses, but the government plays a major part in

allocating resources. The resources are obtained from business and workers in the form of taxes.
DEMAND AND SUPPLY

The market demand curve indicates the maximum price that buyers will pay to purchase a

given quantity of the market product.

The market supply curve indicates the minimum price that suppliers would accept to be

willing to provide a given supply of the market product.

In order to have buyers and sellers agree on the quantity that would be provided and

purchased, the price needs to be a right level. The market equilibrium is the quantity and

associated price at which there is concurrence between sellers and buyers.

From the above graphical presentation, we can clearly see the point at which the supply and

demand curves intersect with each other which we call as Equilibrium point.
Market Equilibrium

Market equilibrium is determined at the intersection of the market demand and market

supply. The price that equates the quantity demanded with the quantity supplied is the

equilibrium price and amount that people are willing to buy and sellers are willing to offer at the

equilibrium price level is the equilibrium quantity.

A market situation in which the quantity demanded exceeds the quantity supplied shows

the shortage of the market. A shortage occurs at a price below the equilibrium level. A market

situation in which the quantity supplied exceeds the quantity demanded, there exists the surplus

of the market. A surplus occurs at a price above the equilibrium level.

If a market is not at equilibrium, market forces try to move it equilibrium. Let’s have a

look − If the market price is above the equilibrium value, there is an excess of supply in the

market, which means there is more supply than demand. In this situation, sellers try to reduce the

price of their good to clear their inventories. They also slow down their production. The lower
price helps more people to buy, which reduces the supply further. This process further results in

increase in demand and decrease in supply until the market price equals the equilibrium price.

If the market price is below the equilibrium value, then there is excess in demand. In this

case, buyers bid up the price of the goods. As the price goes up, some buyers tend to quit trying

because they don't want to, or can't pay the higher price. Eventually, the upward pressure on

price and supply will stabilize at market equilibrium.

 DEMAND AND ELASTICITIES

DEMAND ELASTICITY- is a measure of how much the quantity demanded will change if

another factor changes.

Changes in Demand

Change in demand is a term used in economics to describe that there has been a change,

or shift in, a market's total demand. This is represented graphically in a price vs. quantity plane,

and is a result of more/less entrants into the market, and the changing of consumer preferences.

The shift can either be parallel or nonparallel.

Extension of Demand

Other things remaining constant, when more quantity is demanded at a lower price, it is called

extension of demand.

Px Dx

15 100 Original

8 150 Extension
Contraction of Demand
Other things remaining constant, when less quantity is demanded at a higher price, it is called
contraction of demand.

Px Dx

10 100 Original

12 50 Contraction

Concept of Elasticity

Law of demand explains the inverse relationship between price and demand of a

commodity but it does not explain to the extent to which demand of a commodity changes due to

change in price.

A measure of a variable's sensitivity to a change in another variable is elasticity. In

economics, elasticity refers the degree to which individuals change their demand in response to

price or income changes.

Elasticity of Demand

Elasticity of Demand is the degree of responsiveness of change in demand of a commodity due

to change in its prices.

Importance of Elasticity of Demand

 Importance to producer − A producer has to consider elasticity of demand before

fixing the price of a commodity.

 Importance to government − If elasticity of demand of a product is low then

government will impose heavy taxes on the production of that commodity and vice –

versa.

 Importance in foreign market − If elasticity of demand of a produce is low in the

international market then exporter can charge higher price and earn more profit.

TYPES OF ELASTICITY OF DEMAND

1. Price Elasticity of Demand: The price elasticity of demand, commonly known as the

elasticity of demand refers to the responsiveness and sensitiveness of demand for a product to

the changes in its price.

Elasticity = % Change in Quantity Demanded

% Change in Price

 If PED is Less than one ( <1), it means PED is inelastic.

 If PED is Greater than one (>1), PED is elastic.

 If PED is Equals to 1, PED is unit elastic

 Classification of Price Elasticity

Elastic Demand – when a small change in a product’s price results in a significant

change in the quantity demanded.

Inelastic Demand – when a change in a product’s price has only a slight effect on the

quantity demanded.
Income Elasticity of Demand

The income is the other factor that influences the demand for a product. Hence, the

degree of responsiveness of a change in demand for a product due to the change in the income is

known as income elasticity of demand. The formula to compute the income elasticity of demand

is:

3. Cross Elasticity of Demand

The cross elasticity of demand refers to the change in quantity demanded for one

commodity as a result of the change in the price of another commodity. This type of elasticity

usually arises in the case of the interrelated goods such as substitutes and complementary goods.
 The two commodities are said to be complementary, if the price of one commodity falls,

then the demand for other increases, on the contrary, if the price of one commodity rises the

demand for another commodity decreases.

While the two commodities are said to be substitutes for each other if the price of one

commodity falls, the demand for another commodity also decreases, on the other hand, if the

price of one commodity rises the demand for the other commodity also increases.

WHAT FACTORS INFLUENCE A CHANGE IN DEMAND ELASTICITY

Price

One factor that can affect demand elasticity of a good or service is its price level. For example,

the change in the price level for a luxury car can cause a substantial change in the quantity

demanded. If the luxury car maker has a surplus of cars, it may decrease prices to increase the

quantity demanded, and therefore reduce inventory and increase the company's total revenue.

Income

Also known as the income effect, the income level of a population also influences the demand

elasticity of a good or service. For example, suppose an economy is facing a downturn and many

workers are laid off. The shift in the income level of the majority of a population causes luxury

items to be more elastic. Suppose there is a decrease in the average income level of an entire

economy; luxury items such as luxury cars and flat-screen televisions experience a high elasticity

of demand. Many people opt to save money rather than splurge on luxury items during an

economic downturn.
Substitutability

If there is a readily available substitute for a good or service, the substitute affects the elasticity

of demand of that good or service. The availability of a substitute makes demand for a good or

service sensitive to price changes. For example, suppose the price level of Florida oranges

increases due to a cold front that passes through the state. A close substitute for Florida oranges

is California oranges. A rise in the price of Florida oranges encourages consumers to buy

California oranges.

Change in Consumer Preferences

An important factor which determines the demand for a good is the tastes and preferences

of the consumers for it. A good for which consumers’ tastes and preferences are greater, its

demand would be large and its demand curve will therefore lie at a higher level. People’s tastes

and preferences for various goods often change and as a result there is change in demand for

them.

Changes in Prices of the Related Goods:

The demand for a good is also affected by the prices of other goods, especially those

which are related to it as substitutes or complements. When we draw the demand schedule or the

demand curve for a good we take the prices of the related goods as remaining constant.
 Therefore, when the prices of the related goods, substitutes or complements, change, the

whole demand curve would change its position; it will shift upward or downward as the case

may be. When the price of a substitute for a good falls, the demand for that good will decline and

when the price of the substitute rises, the demand for that good will increase.

For example, when price of tea and incomes of the people remain the same but the price

of coffee falls, the consumers would demand less of tea than before. Tea and coffee are very

close substitutes. Therefore, when coffee becomes cheaper, the consumers substitute coffee for

tea and as a result the demand for tea declines. The goods which are complementary with each

other, the fall in the price of any of them would favorably affect the demand for the other.

For instance, if price of milk falls, the demand for sugar would also be favorably affected.

When people would take more milk, the demand for sugar will also increase. Likewise, when the

price of cars falls, the quantity demanded of them would increase wphich in turn will increase

the demand for petrol.

PRICE CEILING AND PRICE FLOORING

Price ceilings and price flooring are basically price controls.

Price controls are government-mandated legal minimum or maximum prices set for specified

goods, usually implemented as a means of direct economic intervention to manage the

affordability of certain goods.

Price Ceilings

Price ceilings are set by the regulatory authorities when they believe certain commodities are

sold too high of a price. Price ceilings become a problem when they are set below the market

equilibrium price.

There is excess demand or a supply shortage, when the price ceilings are set below the market

price. Producers don’t produce as much at the lower price, while consumers demand more

because the goods are cheaper. Demand outstrips supply, so there is a lot of people who want to

buy at this lower price but can't.

Price Flooring

Price flooring are the prices set by the regulatory bodies for certain commodities when they

believe that they are sold in an unfair market with too low prices.

Price floors are only an issue when they are set above the equilibrium price, since they have no

effect if they are set below the market clearing price.

When they are set above the market price, then there is a possibility that there will be an excess

supply or a surplus. If this happens, producers who can't foresee trouble ahead will produce

larger quantities.
 DEMAND FORECASTING

Demand

Demand is a widely used term, and in common is considered synonymous with terms like

‘want’ or 'desire'. In economics, demand has a definite meaning which is different from ordinary

use. In this chapter, we will explain what demand from the consumer’s point of view is and

analyze demand from the firm perspective.

Demand for a commodity in a market depends on the size of the market. Demand for a

commodity entails the desire to acquire the product, willingness to pay for it along with the

ability to pay for the same.

Law of Demand

The law of demand is one of the vital laws of economic theory. According to the law of

demand, other things being equal, if the price of a commodity falls, the quantity demanded will

rise and if the price of a commodity rises, its quantity demanded declines. Thus other things

being constant, there is an inverse relationship between the price and demand of commodities.

Things which are assumed to be constant are income of consumers, taste and preference,

price of related commodities, etc., which may influence the demand. If these factors undergo

change, then this law of demand may not hold good.

Definition of Law of Demand

According to Prof. Alfred Marshall “The greater the amount to be sold, the smaller must be the

price at which it is offered in order that it may find purchase. Let’s have a look at an illustration

to further understand the price and demand relationship assuming all other factors being constant

Item Price (Rs.) Quantity Demanded (Units)

A 10 15

B 9 20

C 8 40

D 7 60

E 6 80

In the above demand schedule, we can see when the price of commodity X is 10 per unit, the

consumer purchases 15 units of the commodity. Similarly, when the price falls to 9 per unit, the
quantity demanded increases to 20 units. Thus quantity demanded by the consumer goes on

increasing until the price is lowest i.e. 6 per unit where the demand is 80 units.

The above demand schedule helps in depicting the inverse relationship between the price and

quantity demanded.

THEORY OF CONSUMER BEHAVIOR

The demand for a commodity depends on the utility of the consumer. If a consumer gets

more satisfaction or utility from a particular commodity, he would pay a higher price too for the

same and vice - versa.

In economics, all human motives, desires, and wishes are called wants. Wants may arise

due to any cause. Since the resources are limited, we have to choose between urgent wants and

not so urgent wants. In economics wants could be classified into following three categories −

 Necessities − Necessities are those wants which are essential for living. The wants

without which humans cannot do anything are necessities. For example, food,

clothing and shelter.

 Comforts − Comforts are the commodities which are not essential for our living

but are required for a happy living. For example, buying a car, air travel.

 Luxuries − Luxuries are those wants which are surplus and costly. They are not

essential for our living but add efficiency to our lifestyle. For example, spending

on designer clothes, fine wines, antique furniture, luxury chocolates, business air

travel.
 Marginal Utility Analysis

Utility is a term referring to the total satisfaction received from consuming a good or

service. It differs from each individual and helps to show the satisfaction of the consumer after

consumption of a commodity. In economics, utility is a measure of preferences over some set of

goods and services.

Marginal Utility is the additional satisfaction a consumer gains from consuming one

more unit of a good or service. Marginal utility is an important economic concept because

economists use it to determine how much of an item a consumer will buy.

Marginal utility and willingness to pay

Marginal utility is the change in total satisfaction from consuming an extra unit of a good or

service

 Beyond a certain point, marginal utility may start to fall (diminish)

 In our example, this happens with the 4th unit where MU falls to 12

 The 8th unit carries zero marginal utility i.e. total utility stays the same

 If marginal utility is falling, then consumers will only be prepared to pay a lower price

 This helps to explain the downward sloping demand curve

Quantity Consumed Total Utility (TU) Marginal Utility (MU)

1 10 10
2 24 14
3 40 16
4 52 12
5 61 9
6 68 7
7 72 4
8 72 0

Economists use the concept of marginal utility to measure happiness and pleasure, and

how that affects consumer decision making. They have also identified the law of diminishing

marginal utility, which means that the first unit of consumption of a good or service has more

utility than the next units of consumption.

CONCLUSION

Forecasting plays a major role in decision making because forecasts are useful in improving the

efficiency of the decision-making process. Businessmen use various qualitative and quantitative

demand forecasting techniques to predict future demand for products and accordingly take

business decisions. Businessmen can understand the changes taking place in the economy in a

better fashion by undertaking economic forecasting. Risk and uncertainty are the two major

components of the business decision-making process. Risk is a condition where the businessman

can measure the possible outcomes and losses arising from a certain decision. However,

uncertainty arises when the risk involved in decision-making cannot be calculated by

businessmen. Since huge investment decisions have to be made by businessmen, decision

making should be done with utmost care because such decisions are irreversible. Companies

therefore use capital budgeting as a tool to effectively plan and control such huge investment

decisions.