what are the four basic limitations of utility analysis?
1. The assumption that utility can be measured cardinally (or numerically) is not true as utility is a subjective concept and varies from person to person and from time to time.
2. Utility analysis assumes that marginal utility of money is constant. This assumption is unrealistic.
3. There is no verification of law of diminishing marginal utility.
4. The utility analysis ignores the substitution and income effects.
The use of utility theory in capital budgeting is not common. It suffers from a few limitations. First, in practice, difficulties are encountered in specifying a utility function. For small firms, the utility function of the owner or one dominate share holder may be used to guide the decision making process of the firm. Second, even if the owners or a dominant share holders utility function be used as a guide, the derived utility function at a point of time is valued only for that one point of time. Third, it is quite difficult to specify the utility function if the decision is taken by a group of persons. Individuals differ in their risk preferences. As a result, it is very difficult to derive a consistent utility function for the group.