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Capital budgeting process is the process by which firms analyze possible investments. The process typically involves the gathering of critical information, such as costs and estimates of potential revenue. The method of capital budgeting must also be chosen, and would typically include determining an appropriate discount rate for the company as well. There are a number of different methods that can be used to help make capital budgeting decisions. Payback period is the period in which the initial investment is paid back -- typically the shorter the payback period the better. Other methods include the profitability index, return on book value and the internal rate of return (NetMBA, 2010). The most popular method for making capital budgeting decisions in the net present value (NPV). This method focuses on the time value of money, and uses the principles of discounting future cash flows to analyze the incremental...
The discount rate reflects the company's cost of capital and/or the project risk, and any project with a positive net present value should theoretically be approved.
The importance of calculating real options in finance is that each option has an opportunity cost. Options to delay, expand and abandon carry value that is associated with the opportunity cost of that option. For example, if a company has an option to abandon a project, this could allow the company an easier means of escaping a project that has turned bad. Such an option could allow for greater cost savings. Thus, a price should be associated with that option.
There are a number of different methods of valuing stocks. The P/E ratio is one method, in that either the P/E of a similar company can be applied to the earnings of the target company, or that the P/E ratio of the…
Works Cited:
NetMBA (2010). Capital budgeting. NetMBA.com. Retrieved July 23, 2011 from http://www.netmba.com/finance/capital/budgeting/
Capital Budget Processes and Techniques People often ask what happens when there is a surplus of imports brought into the U.S. Many think that we just have more of what we brought in to be able to hang on to and sell at a later date but that is not the case. When there is a surplus of the products that have been brought in then the price of what the
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
When a range of options are presented to management, the capital budgeting process must be used to determine the costs and cash flows associated with each option. However, the capital budgeting process is only as valuable as the inputs and assumptions. If the assumptions are not grounded in reasonable analysis and quality research, the process will not yield a valuable result. If the numbers that are input into 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
I would suggest therefore that the authors work towards a practical output. Their underlying assumptions about the nature of capital budgeting for research and development projects are strong, but their output is unwieldy. Coming from the perspective of someone who would be engaged in the capital budgeting exercise, I would want to have a model to which I assign my staff and expect a useable result. Interestingly, the authors appear to
Capital Budgeting and Cost of Capital Capital budgeting is a multifaceted process that is crucial to good investment decisions by a business or company. This complicated process is defined as a procedure of determining whether an investment is beneficial or not. In essence, capital budgeting helps an organization or company to examine the attractiveness and profitability of an investment opportunity. During this process, companies have several opportunities, which are weighed depending