Capital Budgeting Problem
MBA612, Dr. Schieuer
By: Dean Anderson, Terry Sutton,
Sawan Tamang, Karuna Mishra,
Capital Budgeting Process: Capital budgeting (or investment appraisal) is the planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures (Sullivan & Sheffrin, 2003). The capital budgeting process involves three basic steps: 1. Identify potential investments
2. Evaluate the set of opportunities, choosing those that create shareholder value, prioritize 3. Implement and monitor the investment projects selected The capital budgeting process begins with an idea and ends with implementation and monitoring. In this particular problem we are focusing on the second step in the process: analyzing the merits of the investment proposal to expand and simultaneously replace old equipment. There are analytical tools that weigh the merits of investment projects on several dimensions. To decide which investments to undertake, managers need an analytical tool that: (1) is easy to apply and explain to nonfinancial personnel; (2) focuses on cash flow, not accounting measures; (3) accounts for time-value of money; (4) adjusts for differences in risk across projects; and (5) leads to higher firm value in any company (Graham, Smart, Megginson, 2010). All things being equal, managers would prefer an easily applied capital budgeting technique that considers cash flow, recognizes the time value of money, fully accounts for expected risk and return, and ultimately leads to higher stock values. Glossary of Capital Budgeting Terms and Concepts:
Capital budgeting techniques include the payback period, discounted payback period, which are less sophisticated techniques because they do not deal with the time value...
References: Graham, J.R., Smart, S.B., & Megginson, W.L., (2010). Corporate Finance 3rd Edition, South-Western Cengage Learning, Mason, OH.
Sullivan, A., Sheffrin, S.M., (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 375.
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