Preview

Capital budgeting and investment decisions

Good Essays
Open Document
Open Document
503 Words
Grammar
Grammar
Plagiarism
Plagiarism
Writing
Writing
Score
Score
Capital budgeting and investment decisions
According to Attrill and Mclaney, 2009, there are four (4) approaches to capital budgeting. The net present value (NPV) is one of such and is a summation of all discounted cash flows(Present Value) associated with whichever project(s) are undergoing appraisal. Every appraisal method have decision rules, examples include the Payback Period(PBP) which stipulates the approval of projects that pays back the initial investments within a specific period. For this method (Net Present Value) to be most effective, from the pool of prospective projects under review, only projects that produce a positive net present value should be undertaken, and projects that produce negative figures should be ignored and in instances where mutually exclusive projects are involved, management should thus undertake the project that generated the highest positive net present value. There are however two types of projects that can be undertaken, these are independent projects that are not affected by the cash flows of other projects, and on the other hand is the mutually exclusive projects that means that there are two ways at accomplishing same results.

Investment involves making an outlay of something of economic value, usually cash, at one point in time, which is expected to yield economic benefits to the investor at some other point in time. (Atrill and Mclaney, 2009). Among all the methods of appraisals and despite the fact that this method is however more difficult than the other methods to calculate, the Net Present Value represents the most logical approach, business owners and investors can utilize when making an investment decision / during capital budgeting. When compared to other methods of project appraisal, it particularly stands out.The essential feature of investment decisions is time, (Atrill andMclaney, 2009) and this method particularly recognizes the importance and calculates the time value of money, furthermore, this method measures in absolute terms, the

You May Also Find These Documents Helpful

  • Good Essays

    Phuket Beach Case

    • 1695 Words
    • 7 Pages

    1. To determine for each of the projects the initial outlay, relevant incremental cash flows and the appropriate discount rate to use for discounting the incremental cash flows;…

    • 1695 Words
    • 7 Pages
    Good Essays
  • Good Essays

    1. Victoria Chemicals evaluate its capital-expenditure proposals in four ways. They are average annual addition to earnings per share, payback period, net present value, and internal rate of return. An earnings per share method is to indicate a company’s profitability. For Victoria Chemical, this was calculated with the average annual earnings per share contribution of the engineering-efficiency project over its entire economic life. However, for the basis of the calculation, the project’s initiator used the most recent fiscal year-end’s outstanding shares. If possible, using the company’s average weighted number of outstanding shares because this will change over the project’s lifetime. A payback period method is a simple way to decide if this project is reverting from loss to gain within a given period. For Victoria Chemicals engineering-efficiency project, the maximum payback period was six years and the calculation turns out to be 3.8 years. According to this result, the company would accept the project but this method does not consider the possible cash flows after six years. Even though the project is assuming the payback will be in 3.8 years, but it’s unclear how much needs to be invested before the 3.8 years. Next is the net present value which focuses on all cash flows and incorporates discounted cash flows based on time and risk. This is the best method to determine whether to accept the engineering-efficiency project or not because if the result is positive, it will increase shareholders’ wealth. Although the net present value is the best method but it’ll be better if combined with the result of internal rate of returns calculation. The rate shows when the net present value of the project will reach zero. It is an important companion statistic in addition to net present value. The requirement of the engineering-efficient project requires internal rate of returns to be greater than 10% and the result was 24.3%. In conclusion, this project…

    • 481 Words
    • 2 Pages
    Good Essays
  • Satisfactory Essays

    6. When using Net Present Value (NPV) to make an investment decision, a project is acceptable if NPV is…

    • 2381 Words
    • 10 Pages
    Satisfactory Essays
  • Powerful Essays

    “One of the key areas of long-term decision-making that firms must tackle is that of investment - the need to commit funds by purchasing land, buildings, machinery and so on, in anticipation of being able to earn an income greater than the funds committed”. (Investment Appraisal sheet). A Capital Budgeting Process essentially defined as, “the process by which the financial manager decides whether to invest in specific capital projects or assets” (Capital Budgeting, Decision Process, Procedure, definition) is put in place within companies in order to sift through and make decisions regarding viable major investments. The various stages of the Capital Budgeting Process are (a) Forecasting investment decisions; (b) Identifying projects to meet needs; (c) Appraising the investments; (d) Selecting the best alternatives; (e) Making the expenditure; (f) Monitoring projects. (Investment Appraisal sheet). There are also various components of the process which include, the initial investment outlay, which is the initial cash outflow on the purchase of an asset less the net cash proceeds from the disposal of the replaced asset; Net cash savings or benefits or savings from operations; Terminal cash flow; and the NPV technique. (Capital Budgeting, Decision Process, Procedure, definition). Management accounting uses the Net Present Value (NPV) technique, which in simple terms practices an explicit comparison of the returns from a specific project with the relevant opportunity cost of capital, to appraise and manage investment decisions. NPV is an indicator of how much value an investment adds to the firm. (Net Present Value, 2009)…

    • 2063 Words
    • 9 Pages
    Powerful Essays
  • Better Essays

    Victoria Chemicals

    • 788 Words
    • 4 Pages

    This evaluation scheme above enables the firm to analyse capital-expenditure project from different angle and prospective.…

    • 788 Words
    • 4 Pages
    Better Essays
  • Good Essays

    The Investment Detective

    • 439 Words
    • 2 Pages

    3. What rank should we assign to each project? Why do payback and NPV not agree completely? Which criterion is best?…

    • 439 Words
    • 2 Pages
    Good Essays
  • Best Essays

    Project Evaluation

    • 3009 Words
    • 13 Pages

    Financial analysis is an essential part of project appraisal which is necessary to estimate the…

    • 3009 Words
    • 13 Pages
    Best Essays
  • Good Essays

    Various objectives are usually considered when projects are evaluated, including economic desirability, technical, environmental, social and/or political factors. As the decision maker tries to maximize or minimize outcomes associated with each objective depending on its nature, the evaluation criteria could be of various natures. While financial measures (Net Present Value and Internal Rate of Return) are of quantitative type, the ones that reflect technical, environmental or social objectives are usually of qualitative nature. (Maciej Nowak, 2006)…

    • 967 Words
    • 4 Pages
    Good Essays
  • Better Essays

    In this report, I aim to present a thorough outline of a method of project appraisal: Net Present Value (NPV). This is a dynamic investment appraisal that utilizes a discounted cash flow method. Along with the IRR (internal Rate of Return), the NPV method is regarded as more comprehensive than the simpler, more traditional Payback method. It withal considers the time value for money principle. I will compare it to a simpler method of project appraisal: the Payback method. This is a much simpler method, conventionally used by diminutively minuscule businesses. I will consider the strengths and impuissance 's of both methods, and what implicative insinuations these have when choosing which method to utilize. Lastly, I will provide a demonstration of the NPV method utilizing Microsoft Excel.…

    • 978 Words
    • 4 Pages
    Better Essays
  • Best Essays

    References to Use in Ciam

    • 858 Words
    • 4 Pages

    Akalu, M. (2003). “The process of investment appraisal: the experience of 10 large British and Dutch companies.” International Journal of Project Management 21: 355-362.…

    • 858 Words
    • 4 Pages
    Best Essays
  • Powerful Essays

    | Explain the concept of the time value of money (present value and future value).…

    • 9203 Words
    • 37 Pages
    Powerful Essays
  • Good Essays

    Business Finance

    • 1349 Words
    • 6 Pages

    A: Net Present Value is a method to evaluate a project value. NPV requires an estimate of the cost of capital. Therefore, to understand what is NPV, Discount rate should be completely understand. The first advantage is that NPV gives important to the time value of money. Secondly, in the calculation of NPV, both after cash flow and before cash flow over the life span of the project are considered. Thirdly, profitability and risk of the projects are given high priority. Fourth, NPV helps in maximizing the firm's value. On contrary, NPV is difficult to use. Also, NPV cannot give accurate decision if the amount of investment of mutually exclusive projects are not equal. One difficulty would be calculation of appropriate discount rate. Meanwhile, NPV may not give correct decision when the projects are of unequal life.…

    • 1349 Words
    • 6 Pages
    Good Essays
  • Better Essays

    This paper covers the implementation of three investment appraisal methods. Initially, importance of investment appraisal has been analyzed. Secondly, calculations have been done for Net present value, Payback period, Internal Rate of Return for two projects. Subsequently, selection of project has been done with assistance of results from calculations. After that, it has been discussed that how does change in cost of capital affect NPV and IRR. In addition to above, sensitivity of NPV in long run and short run has been analyzed. Finally, difference among NPV and IRR methods and their effectiveness have been discussed…

    • 1942 Words
    • 8 Pages
    Better Essays
  • Good Essays

    Projecting Cash Flow

    • 314 Words
    • 2 Pages

    After estimating cash flow which arises from an investment opportunity, the techniques apply to this cash flow to assess the attractiveness of the opportunity. The techniques produce a result in terms of the length of time to pay back the investment (the payback period and the discounted payback period) the value added (net present value) the benefit cost ratio ( the profitability index) or the return (the internal rate of return and modified internal rate of return).…

    • 314 Words
    • 2 Pages
    Good Essays
  • Good Essays

    (The evaluation of two mutually exclusive projects with varying lives requires careful examination of the existence of the reinvestment opportunities at the end of the different economic lives of the projects. The current article deals with a method that may be adopted in situations wherein the level of investments, the life of the projects and cash inflows (or outflows) are unequal.)…

    • 965 Words
    • 4 Pages
    Good Essays

Related Topics