Managerial Accounting and Legal Aspect of Business/ACC 543
May 24, 2010
Capital Budget Recommendation
Guillermo Navallez is the owner of Guillermo Furniture, a company that manufactures midgrade and high-end sofas. Recent changes in the business environment and economy have prompted Guillermo act fast before he is forced out of business. After doing some research, Guillermo identified some possible investment options that would improve his businesses' financial condition. A capital budget evaluation will help to determine which capital investment decisions will provide the greatest returns. Choosing the right techniques could is very important to the success of the project and organization. An overview of each possible technique provide it this paper before explaining how the how the recommendation was made.
After considering Guillermo's circumstance, evaluating Guillermo Furniture's data sheet and using the present value index method to compare his alternative capital investment opportunities, a recommendation was ready to be made to Guillermo. It is recommended that Guillermo select the high technology investment solution because of its higher return rate.
Capital Budget Evaluation Techniques and the Recommended course of action
Capital Budget Evaluation Techniques
Capital investment decisions could be very complex. Several capital budget techniques available to use and numerous factors to keep in mind. For example, the time value of money may be an important factor to consider when using some of the techniques to evaluate a course of action. The payback method and unadjusted rate of return method as another example. They are techniques that ignore the time value of money. The net present value method and the internal rate of return method are techniques that use the time value of money are. The time value of money is important to consider in the evaluations Guillermo Furniture because the value of money is changing more frequently in the current economy. In addition, the time value of money in a capital investment decision means more accuracy in figuring out the present value of an investment. According to Edmond et al., the more money involve with the investment the further off the calculate may be if the time value of money is not included. However, when investment cost are small or when cash flows extend over a short period, it is not necessarily important include the time value of money. Because the payback method and unadjusted rate of return method are more simpler to use, it would be more appropriate to use one of these techniques in cases in which the investment cost is low. A brief overview of the possible techniques to evaluate a capital investment is provided below.
Payback Method. The payback method is a technique used to figure out when the initial cash outflow will be recovered. For example, if Guillermo decides to invest in one of those high-tech solution laser lathes. If he initially spends $500,000 dollars for the cost of the investment and receives a cash inflow of $200,000 annually, his payback will be two and half years. This technique is valuable when decisions have to be made quickly and accuracy is most important factor. Using this technique will allow decision makers to compare two alternative investment options and choosing the one that has the best payback period. According to Edmonds et al., the formula for payback is the payback period equals the net cost of investment divided by the annual net cash inflow.
Net Present Value. In net present value (NPV) the difference between the present...