Question

What changes have taken place in capital budgeting techniques used by U.S. companies? Explain in detail the impacts of these budgeting techniques.

Answer 1

The capital budgeting process is one of the most important part of Investment decision making process. The company uses different types of approach to determine the capital budgeting decision like net present value method, pay back period, Discounted pay back period, accounting rate of return, internal rate of return. Each of these methoods have some advantage over the others and some disadvantage over the other but in recent years due to the advancement in technology, these same approach can be applied in slightly better way to get the outcome. Some of the changes that companies have used in capital bufgeting techniques are:

• Sensitivity analysis : Since the entire capital budgeting process is based on assumption, sensitivity analysis help in looking at the output while tweaking one variable at a time. It helps you analyze if one variable is changed in the entire process what is the outcome going to be. For example if we change the Interest rate assumption what is the outcome of the project?
• Scenario analysis : Scenario analysis is changing the assumption behind more than one variable and changing the variable input and then analysing the output. It helps in assessing what if many variables are changed. For example lets suppose we change the interest rate assumptio as well as cash flow estimation, is the project still financially viable.
• Monte carlo simulation : A monte carlo simulation method that is used to model the probability of different outcomes. It helps in understanding the risk associated with differnt projects and compare the expected return with that.
• What if analysis : There are very small differences between sensitivity analysis, scenario analysis and what if analysis. What if analysis basically changes the the variable input and then compares the outcome. It can be performed in excel. What if analysis is basically dependednt on the user how he wants to change the variable input.