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Capital Budgeting
Investment Appraisal or Capital Budgeting is the planning process used to determine a company's long-term investments, including such things as new plants, new machinery, new products, replacement machinery, and research and development projects. Capital expenditures range from medium to very large and also have a significant impact on the company's financial performance as, more often than not, a high level of importance is placed on the project selection. This process is referred to as capital budgeting within the industry.
In Capital Budgeting, many formal methods are used, including such techniques as:
Profitability index
Net present value
Internal Rate of return
Equivalent annuity
Modified Internal Rate of Return
All these above methods use incremental cash flow from projects or from each potential investment.
Criteria for capital Budgeting Decisions
Selecting projects is one of the criteria necessary in every capital budgeting decision. Sometimes shareholders of the company may want the company to select projects that will quickly surge in money inflows, while others may want to give little importance to short-term performance and instead place the emphasis on long-term growth. It would be difficult for the company to satisfy its shareholders with differing interests, but there is a solution-Net Present Value.
Using Net Present Value (NPV) as criteria to select projects assumes proficient capital markets. In other words, in order to work the company has to have access to whatever budget is needed to continue the positive Net Present Value projects. Sometimes there may also be capital ration and the concept of capital budgeting process becomes more and more complex.
Alternative Rules for Capital Budgeting
While NPV is the rule which maximizes value of shareholders, some companies use other strategies for their capital budgeting decisions. Common alternative strategies include:
Profitability Index
Internal Rate of Return (IPR)
Payback Period
Return on Book Value
Investment decisions made from the Profitability index and Internal Rate of Return methods agree with those of Net Present Value. Decisions made using the return on book value and payback period method usually are suboptimal from the point-of-view of increasing shareholders value.
Litzenberger and Joy (1975) note that in a decentralized system, quantitative measures are more common for evaluating projects, but they also note that for larger projects there is some degree of centralization. This is the case with Stryker, where the most substantial projects are approved by the Board of Directors. Ang (1986) notes, however, that there can be agency problems where the interests of the division are misaligned with the
"MIRR: A better measure." Business Horizons. 51(4), 321-329. Cited in: http://econpapers.repec.org/article/eeebushor/v_3a51_3ay_3a2008_3ai_3a4_3ap_3a321-329.htm McClure, B. (n.d.). "Taking Stock of Discounted Cash Flow." Investopedia. Cited in: http://www.investopedia.com/articles/03/011403.asp?partner=answers "Modified Internal Rate of Return." (2009). Cited in: http://www.thinkanddone.com/finance/mirr.html Parrino, R, & D. Kidwell. (2009). Fundamentals of Corporate Finance. (Vol. 1, Ed.). Wiley Custom Solutions. Smart, S. And WL. Megginson. (2008). Corporate Finance. Thompson Learning. Sullivan, A. And S. Sheffrin. (2003). Economics: Principles in Action. Prentice-Hall. The IRR is the rate of return that makes the
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Budget Plan for $10 Million Fund Allocation Positive economic development in any city in the United States relies on the provision of effective, efficient, and strong infrastructures that will attract investment to generate job opportunities in the city. A central goal of any city is also to improve health outcomes for the residents to improve their health outcomes. City public officials should also provide safety and securities, and improve students achievements
Thus, the paper provides the following recommendations on the strategies that the company will use to prepare its 3-year financial plan to achieve its corporate objectives. First, Aztec needs to rely more on the share capital as source of fund than raising fund from the bank loan. Loan capital is the fund borrowed from the bank while the share capital represents the funds raised by selling shares to the public. Typically,
28% This gives project B. An IRR of -0.028% Part C Using the above assessments each may indicate which investment may be preferred. Using the payback period project a has a payback period of 4 years, whereas project B. has a payback period of 3 years 8 months. If the fastest payback period is preferred than project B. will be chosen. The NPV which discounts the net revenues into a net present value shows