Question

A recent survey of American CFOs conducted by academics John Graham and Cambell Harvey asked CFOs to rate the frequency of their use of various capital budgeting techniques. Graham and Harvey found that 75.7% of CFOs always, or almost always, relied on IRR to make capital budgeting decisions, and 74.9% relied on NPV. In particular, larger firms were more likely to rely on these techniques, as were firms with proportionately more debt.

You are being asked to put yourself in the shoes of a CFO. Describe and discuss what capital budgeting techniques you would rely upon and why?

Answer 1

Various types of capital budgeting techniques I will be relying upon,and they would be as follows-

A. Net present value- Net present value is a method of capital budgeting in which cash outflows and cash inflows will be discounted at the present value in order to accept the best projects so this will be helpful in order to select various projects based upon their cash flow generation abilities

B. Internal rate of return is rate of return which will be equalising the cash outflows and the cash inflows at a specific rate so it will be helpful in order to finding out the break even point and it will also be helpful in order to finding out the hurdle rate so that it can be maintained with best possible acceptability criteria.

C. Equivalent annual annuity will be the most preferable method to be used when I will be having mutually inclusive projects and they will be having unequal life so net present value and internal rate of return will not be providing with the best possible estimate of such projects and equivalent annual annuity will be helping me with finding out the best suitable projects according to the equivalent annual annuityannuity of various projects which have unequal lights.

I will also be using various kinds of methods like discounted payback period method in order to find out the cash equivalents to the initial outlay.