Question

Question #6:

Management uses several capital budgeting methods in evaluating projects for possible investment. Identify those methods that are more desirable from a conceptual standpoint, and briefly explain what features these methods have that make them more desirable than other methods. Also identify the least desirable method and explain its major weaknesses.

Answer 1

There are many Capital Budgeting techniques. However the technique that focuses on the Time Value of the money gives more accurate results.

These techniques can be briey summarized as below :

Net Present value : The Net Present Value is the Present Value of Cash Inows minus the Presnt Value of Cash inows. This technique measures the Present Value of a Cash Flow stream by discounting the future Cash Flows at a particular interest rate. Hence, if the NPV of a project is positive, a project can be accepted.If negative, it can be rejected.

IRR : IRR or Internal Rate of Return is the rate of return that an investor can expect to earn on the investment.If the IRR is greater than the project's Minimum Rate of return, the project should be accepted, otherwise rejected.

There are other methods like payback method etc. However, since they do not take into account the Time Value of Money, it is less reliable