This website uses cookies to ensure you have the best experience. Learn more

Capital Budgeting Essay

2064 words - 9 pages

Capital Budgeting Techniques
Mona School of Business Financial Management Lecturer: Kathya Beckford

By the end of this session you will understand:
1.

What capital budgeting is
How to calculate and interpret a project’s:
    

2.

Payback Period Discounted Payback Period Net Present Value (NPV) Internal Rate of Return (IRR) Profitability Index (PI)

3.

How to choose projects when capital is rationed

What is capital budgeting?

Capital budgeting is the process of planning expenditure on assets or projects that can have a long-term impact on an institution.

Examples of capital projects
    

Adopting a new enterprise-wide software system Launching a ...view middle of the document...

67 years

Payback Period- Example cont’d
If projects with a payback period of up to 4 years are acceptable, should the firm accept this project? Answer: Yes, since the payback period is less than 4 years.

Payback Period- The Pros

It is easy to calculate

It is easy to explain
It uses cashflows (not accounting profits) It gives a measure of the liquidity of a project

Payback Period- The Cons
 How

to decide maximum allowable payback period? Very subjective value of money not taken into consideration riskiness not accounted for properly

 Time

 Project’s

 Cashflows

beyond the payback period are ignored

 No

connection to maximizing the firm’s value

Discounted Payback PeriodThe Concept
What is it? The discounted payback period for a project is the expected time it will take for the discounted cash flows to recover the original investment. The decision rule: Accept project if its discounted payback period is less than the maximum allowed.

Discounted Payback PeriodExample
A project requires a $100,000,000 investment and is expected to generate the following cash flows in the years after the investment is made
Year
1 2 3 4 5

Cashflow ($)
20,000,000 40,000,000 60,000,000 30,000,000 10,000,000

What is the discounted payback period based on a discount rate of 10%?

Discounted Payback PeriodExample cont’d
Workings:
Year 1 2 3 4 5 Cashflow ($) 20,000,000 40,000,000 60,000,000 30,000,000 10,000,000 PV of Cashflow ($) 18,181,818 33,057,851 45,078,888 20,490,404 6,209,213 Cumulative PV of cashflow ($) 18,181,818 51,239,669 96,318,557 116,808,961 123,018,174

The discounted payback period is somewhere between the end of year 3 and the end of year 4

Discounted Payback PeriodExample cont’d

Use linear interpolation to find the exact figure for the discounted payback period By using linear interpolation, the assumption is that the discounted cashflows occur evenly throughout the year We get: Y–3 = 4–3

100,000,000 – 96,318,557 116,808,961 – 96,318,557 (This is the discounted payback period)

Y = 3.18 years

Discounted Payback PeriodExample cont’d
If projects with a discounted payback period of up to 5 years are acceptable, should the firm accept this project? Answer: Yes, since the discounted payback period is less than 5 years.

Discounted Payback PeriodThe Pros & Cons

The pros and cons are almost the same as with the basic payback period technique Only improvement is that cashflows are discounted However, since cashflows beyond discounted payback period are ignored, TVM still not handled adequately

Net Present Value (NPV)The Concept
What is it? The net present value of a project is the sum of the present values of its expected cash flows.

The decision rule: Accept project if its NPV > 0.

NPV- An Example
A project requires a $100,000,000 investment and is expected to generate the following cash flows in the years after...

Other Papers Like Capital Budgeting

Capital Budgeting Essay

858 words - 4 pages Assignment 3 Exercise 6 PAD 505 Capital Budgeting For Professor By Landis Rush May 13, 2012 In the following paper, we are presented with two options in which to make an investment Options A and B. Options A and B is presented with the following chart data: Options A and B have two initial investments and the goal is to determine which investment is the best option. Option A’s initial investment is $2,000,000 and B is $2,500,000 with

Capital Budgeting Essay

560 words - 3 pages Capital Budgeting Case NPV or net present value illustrated as the present value of an investment’s annual free cash flow less the investment’s initial outlay (Keown, Petty, & Martin 2014 Pg. 314). While assessing both Corporation A and Corporation B, NPV formula’s represented by (present value of all the future annual free cash flows) - (the initial cash outlay). Calculations of Corporation A, has a 10% rate of return and the

Capital Budgeting

1531 words - 7 pages Capital Budgeting Brenda Armstead PPA603: Government Budgeting (MGB524DS) Instructor: Dr. Regis Chapman July 13, 2015 Introduction: According to Lee el at (2008), “Three main factors influence debt capacity: expenditure pressures, resource availability, and the commitment of governmental officials to use resources to meet debt requirements. Assessing resource availability involves analyzing all potential sources of

Capital Budgeting - 3031 words

3031 words - 13 pages WHAT IS CAPITAL BUDGETING? Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select projects is needed. This

Capital Budgeting - 680 words

680 words - 3 pages Bonds are a form of long term debt financing in which an organization issues a bond to raise capital. When a bond is issued the organization is in actuality taking a loan at an interest rate referred to as a coupon which it typically pays on an annual or semiannual basis. The bond then has a maturity date at which time the organization pays back the principal to whoever is holding the bond. For a health care organization who wishes to issue a

Capital Budgeting - 2504 words

2504 words - 11 pages CAPITAL BUDGETING PROCESS HSM 340 3/30/12 Organizations that decide to issue bonds generally have six steps to go through. Let’s discuss them. The first step is for the issuer to select bond counsel and the underwriter or financial advisor. The issuer and the solicitor work with these participants to structure the financing. Some basic questions need to be answered: (1) what is the purpose of the issue -- to fund a capital project, to

Capital Budgeting - 681 words

681 words - 3 pages Capital budgeting Acquisition investment HP should invest in an acquisition investment with Washington Electronics Corporation. Even though PH is among the upcoming electronic and technology company, its projected annual revenues ranges within $800,000 bracket. In the course of merging and other activities, there are substantial problems that are associated with the decision. Just like any other merging activity, in order to estimate the

Capital Budgeting - 786 words

786 words - 4 pages Capital Budgeting Case Learning Team B is considering acquiring another corporation. There are two different companies being considered, with the acquisition cost for each at $250,000. The information given for each business is as follows: Corporation A carries revenue of $100,000 for the first year and increases each year after that by 10%. The expenses for this corporation are $20,000 for the first year which will increase by 15% each year

Stryker Corporation: Capital Budgeting

1847 words - 8 pages Harvard Case Study Stryker Corporation: Capital Budgeting Term Paper Laini Tsang Golden Gate University MS Finance, FI 312 Summer 2013 Stryker’s Capital Budgeting Harvard Case Study Table of Content      Case Background and Summary Pharmaceutical Industry’s Landscape Stryker’s New CERS and why it is “painful”? Propositions Conclusions 2 Stryker’s Capital Budgeting Harvard Case Study Case Background and Summary

Capital Budgeting Process

942 words - 4 pages Capital Budgeting Process These are the six steps that organizations use when they are issuing bonds. These steps are: 1. The healthcare provider plans and prepares for the issuance process. (Cleverley, Chapter 21) 2. The healthcare provider gets evaluated by a credit rating agency. (Cleverley, Chapter 21) 3. The bond is rated by a bond rating agency. (Cleverley, Chapter 21) 4. The healthcare provider provides a note or lease to the

Capital Budgeting Case

681 words - 3 pages Capital Budgeting Case Shawn P. Oeser QRB/501 October 7, 2013 David Gobeli Capital Budgeting Case For the final week of QRB/501 we were asked to complete a Capital Budgeting Case based on two possible corporations for our company. Based on the 5 year projected income statement, 5 year projected cash flow, Net Present Value (NPV), and Internal Rate of Return (IRR); we were to determine which company would be the wiser acquisition. After

Related Essays

Capital Budgeting Essay 567 Words

567 words - 3 pages Part A “Capital budgeting over the years has become a sophisticated process for the finance officer. The different methods available to the finance officer have increased and become more accurate and centred upon the goal of maximizing wealth. However has there been an increase in the usage of these new methods or are decision makers still using the easier methods?” Capital budgeting is a tool management use to make investment decisions

Capital Budgeting Essay 630 Words

630 words - 3 pages Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore, a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this, a sound procedure to evaluate, compare, and select projects is needed. This procedure is called capital

Capital Budgeting Essay 4274 Words

4274 words - 18 pages Capital Budgeting Practices MGMT 640 Section 9040 Professor J.Jain Executive Summary This essay discusses the importance of capital budgeting and analyzes the most common techniques. The most frequently used methods are the net present value (NPV) and internal rate of return (IRR). These are both tools that analyze the present value of the cost of a project as well as the present value of that projects future cash flows. An essential

Capital Budgeting Essay 2791 Words

2791 words - 12 pages Introduction Capital budgeting is the decision-making process that establishes the goals and criteria for planning and investing a firm’s resources in fixed assets or long-term projects. Capital budgeting normally includes the evaluation of projects like land, building, facilities, equipment, vehicle fleets, and so on. Capital budgeting is important for the following reasons: 1. The size of the investments. As discussed throughout