Capital Budgeting Analysis
Amanda Kocanda, DeUndre’ Rushon,
HuongTran,& Morgan Gibreal
MBA 612, Financial Strategy
October 28, 2014
Within this paper, an overview of the general capital budgeting process and how it is implemented within organizations is defined and reported. Key terms related to capital budgeting are also defined. Risk analysis based on the Net Present Value (NPV) is performed on the salvage values before and after sales tax values along with the different sale ranges.
Keywords: NPV, NPV Profile, NPV, IRR, multiple IRRs, ranking conflict of NPV vs. IRR, payback period, profitability index, discount rate, cost of capital concept, cash flow analysis, cash flow timeline, conventional cash flow stream, non-conventional cash flow stream, sunk cost, opportunity cost, independent projects, mutually exclusive projects
Overview of the Capital Budgeting Process
Every business requires some source of funds to maintain operation and competitive advantages. Whether it’s a manufacturing or servicing firm, it requires financing. Financing sources can be obtained through debt, bond issuance, bank loan, equity, and issuance of preferred and/or common stock. The amount of debt and equity builds the firm's capital structure. The firm's corporate or business strategy is the proportion of capital structure it needs to finance its operation. The combination of debt and equity totals the cost of capital for the firm. The cost of capital is the weighted average of each capital source fund. The cost of capital is known as the, Weighted Average Cost of Capital (WACC). The WACC includes many factors as profitability, credit worthiness, debt history, and other finance factors. WACC gives a firm a benchmark to where it should receive any gain. Since firms are continuously trying to improve its infrastructure, business processes, or competitive priorities, WACC is heavily utilized in capital budgeting.
As previously mentioned, a firm or business has to make rational decisions about which project to pursue in order to have a beneficial Return of Investment (ROI). The firm's main objective is to increase the wealth of the stakeholders. Capital budgeting is the process of analyzing cash inflows and outflows of any project in order to determine if its returns will be feasible to the firm's lucrative goals and stakeholders' Internal Rate of Return (IRR). The cash inflows are estimated returns of investment evaluated at a particular market value rate. The initial cash outflow is a disbursement fund to allocate resources to implement the project. Capital budgeting also consists of assessing the Payback Period (PBP) with respect to cash inflows. The PBP evaluates when the firm breaks-even becomes profitable. Capital budgeting is also known as an investment appraisal. Overall, the capital budgeting is a process that firms use to make rational and relative financial decisions for long-term projects.
Glossary of Capital Budgeting Concepts and Terms
2B. A glossary of capital budgeting related concepts and terms (alphabetically listed) with definitions and summary comments regarding the implications of the concepts and terms. At a minimum, the key concepts and terms should include: Cash flow analysis (time zero initial investment cash flows, operating life cash flows, terminal period end of project cash flows) Cash flow timeline, cash inflows and outflows directly related to the production and sale of a firm’s products or services. The cash flow timeline can be calculated as the net income plus depreciation and other noncash charges. Used by financial professionals to focus attention on current and prospective inflows and outflows of cash. Conventional cash flow stream
Cost of capital concept (and implications to valuation)
Discount rate is the interest rate charged to commercial banks and other depository...
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