capital budget reccomendation
Capital Budget Recommendation
Capital Budget Recommendation
There are multiple effective techniques that can be used to evaluate a capital expenditure budget. Some of the most commonly used techniques include net present value, internal rate of return, and payback period. Each evaluation technique will yield the results in different fashions, and often some will yield better results than others. When looking at a capital investment every option must be taken into consideration before coming to a decision that is best for the company. It is important to take each of these techniques into consideration and choose the one that will best represent the decision to be made.
Differentiate between various capital budget evaluation techniques
One evaluation technique is the Net Present Value or NPV. NPV is used to determine how profitable a capital investment will be. Investopedia states that due to the time value of money “a dollar earned in the future will not be worth as much as one earned today.” (Investopedia) Net present value takes into consideration the initial investment then measures cash inflow and cash outflows that come as the result of a capital investment to determine the net present value of the investment.
Internal Rate of Return or IRR is another capital budget evaluation technique. “The higher the internal rate of return, the more profitable the investment.” (Edmonds Ch 24) The internal rate of return can be better described as the rate which the net present value of an investment, including both cash inflows and outflows related to the investment, are equal to zero.
The payback method does not take into consideration the time value of money, which deems it to be less accurate than the NPV or IRR techniques; however this technique is quick and easy to calculate. The payback method can be calculated by dividing the cost of the initial investment by the annual cash flow to determine the payback period. When using the payback method
Capital Budget Recommendation
There are multiple effective techniques that can be used to evaluate a capital expenditure budget. Some of the most commonly used techniques include net present value, internal rate of return, and payback period. Each evaluation technique will yield the results in different fashions, and often some will yield better results than others. When looking at a capital investment every option must be taken into consideration before coming to a decision that is best for the company. It is important to take each of these techniques into consideration and choose the one that will best represent the decision to be made.
Differentiate between various capital budget evaluation techniques
One evaluation technique is the Net Present Value or NPV. NPV is used to determine how profitable a capital investment will be. Investopedia states that due to the time value of money “a dollar earned in the future will not be worth as much as one earned today.” (Investopedia) Net present value takes into consideration the initial investment then measures cash inflow and cash outflows that come as the result of a capital investment to determine the net present value of the investment.
Internal Rate of Return or IRR is another capital budget evaluation technique. “The higher the internal rate of return, the more profitable the investment.” (Edmonds Ch 24) The internal rate of return can be better described as the rate which the net present value of an investment, including both cash inflows and outflows related to the investment, are equal to zero.
The payback method does not take into consideration the time value of money, which deems it to be less accurate than the NPV or IRR techniques; however this technique is quick and easy to calculate. The payback method can be calculated by dividing the cost of the initial investment by the annual cash flow to determine the payback period. When using the payback method
References: Edmonds, T. P., Edmonds, C. D., Olds, P. R., McNair, F.M., Tsay, B.-Y., Schneider, N. W., et al. (2007). Fundamental financial & managerial accounting concepts. New York, NY: McGraw-Hill. Investopedia. Net Present Value - NPV. 2014 Investopedia U.S. Retrieved August 3, 2014. http://www.investopedia.com/terms/n/npv.asp