Question

1. Please read the article on "HOW DO CFOS MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS?" and explain the most popular Capital Budgeting Technique.

Answer 1

"HOW DO CFOs MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS?" was the study conducted by John Graham and Campbell Harvey, Duke University.
They solicited responses from approximately 4400 companies and have received 392 surveys completed and made the study out of it. Around 100 questions were asked in the survey relating to capital structure decisions and capital bugeting techniques.
From the findings of their survey, they found that NPV (Net Present Value) was much widely used capital budgeting technique by the companies.

NET PRESENT VALUE (NPV)

NPV stands for Net Present value. NPV of an investment propsal can be defined as sum of the present vaue of all future cash inflows minus the sum of the present value of all cash outflows.

Example
A project requires an initial investment of $80000 and is expected to generate following cash inflows:
50,000(1st year), 45000 (2nd year), 30000(3rd year), 26000(4th year)
Compute NPV if desired rate of return is 12%
Solution:
(PV of $1 at 12% - these values are taken from present value table)

Year	PV of $1 at 12%	Net cash flow (in $)	PV of cash flow (in $)
1	0.893	50000	44650
2	0.797	45000	35865
3	0.712	30000	21360
4	0.636	26000	16536
		Total =	118411
		Initial investment =	80000
		NPV =	38411

Here, since sum of PV of cash inflow > Initial investment(Cash outflow) = Accept this proposal, since NPV is positive

Decision to accept or reject proposal
If Present Value (PV) of cash inflow > PV of cash outflow = Accept (SInce NPV is positive)
If Present Value (PV) of cash inflow = PV of cash outflow = Accept (SInce NPV is positive)
If Present Value (PV) of cash inflow < PV of cash outflow = Reject (SInce NPV is negative)