Capital Budgeting and Risk Analysis Define the most important capital budgeting techniques. name at least two...

Capital Budgeting and Risk Analysis

Define the most important capital budgeting techniques. name at least two (2) capital budgeting techniques (e.g., NPV, IRR, Payback Period, etc.) that you used to arrive investment decision.

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Expert Solution

Capital budgeting is a process of analysing investments and future returns in order to obtain best returns on investment. This involves ascertaining the initial expenditure to be invested, estimated future cash flows, taxation impact and depreciation and terminal cash flows.

Popularly used capital budgeting techniques

Net present value

It involves discounting the future cash flows occurring during the life of project at discount rate generally weighted avg cost of capital. The selection criteria is projects with higher npv is to be selected.

IRR technique

Internal rate of return involves calculating the project return rate based on pv of outflows and inflows. It is such a rate at which pv of inflows =pv of outflows or npv = 0. Selection criteria is project with irr higher than cost of capital. In case of two projects project with higher irr is selected.

Profitability index method This method calculates the ratio of pv of inflows to pv of outflows. Ideally pi should be greater than one. Generally Project with higher pi is selected.

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