Question

FINA310

UNIT 4

Assignment Details

• How can you utilize capital budgeting techniques in your personal finances to determine whether an investment is a good idea?
• Give an example of a personal purchase or a small business investment venture.
  • Do you think that you made a good investment of your hard-earned capital?
  • Could the capital budgeting techniques in this lesson have helped you with the decision?

Answer 1

· Capital budgeting technique actually helps in assessing whether a project being undertaken is actually going to add value to the company or not. The broad idea is when a project is being taken it should be able to generate a return which compensates for the capital involved and the time and effort of the investor. In personal finance it can actually help in deciding if you are borrowing from the market or investing in a market. When you are borrowing say a home loan then you would want the cost to be low and when you are investing in the market you want the return to be high. It can also help you deciding which credit card to use, which stocks you can invest in and whether if you are using leverage in your investment then what is the return that should be generated on the investment?

· Let’s say I invested in the equity of a company where I bought 1500 shares @ $50 per share at margin from the broker. The initial margin requirement was 60%. So my initial equity investment was (1500*50*0.60) = 45000. The stock did not appreciate much in value but it did pay dividend of $0.80 per share twice in a year. At the end of the year I sold the equity stake for $55 per share so my total return for the year was ( $5 per share + 0.80*2 per share dividend), so total gain of $6.6 per share, so total return if we exclude the margin interest the return was (6.6*1500/45000) = 22%. If we consider the margin interest then the return would be around 18 to 19%.

· Yes, I believe it was a good investment. In a year if you are able to generate such returns then it is good comparative to index.

· Capital budgeting decision actually helps in the process not just in selecting as to which projects to accept but also helps as to what risk to avoid. For example, in the above case my equity was only 60% but, in the scenario, if the stock price has fallen then I would have to close my position or accept loss. In this case how much loss can I bear I should have decided earlier and should have been taken all these things into consideration when deciding whether to buy the stock or not and at what leverage and how much margin interest rate is acceptable.