Final answer:
Financial models face limitations due to imperfect information, difficulty in forecasting future events, and not factoring in long-term needs. The asymmetry of information between firm managers and external investors creates challenges in selecting the most suitable projects for investment. Moreover, financial models may fail in optimal capital allocation and assessing long-term impacts.
Step-by-step explanation:
The limitations of financial models in approving projects or selecting among projects for an organization's project portfolio are significant and multifaceted. One core limitation is dealing with imperfect information, which occurs when there is an asymmetry of information between internal managers and external investors or stakeholders.
Managers within a firm often have better insights regarding potential profits and the viability of projects than outside investors. Furthermore, financial models often struggle to accurately predict future market conditions and the impact of unforeseen events, leading to potential misallocation of resources.
Additionally, financial models may not fully incorporate the long-term need and asset assessments that are crucial for strategic planning and sustaining impact over time.
Firms have various options when choosing between sources of financial capital, including early-stage investment, reinvestment of profits, borrowing, and selling stock. The choice among these sources encompasses a decision on not just raising capital but also the cost of that capital and the obligations it entails.
Due to imperfect information, the process firms undergo to raise financial capital can be fraught with inefficiency and may not align with the most economically optimal decisions.