Question

TYPE PLEASE: In your own words, discuss in detail the four main capital budgeting tools mentioned in the chapter including each of their specific advantages as well as their specific disadvantages.

Answer 1

Capital budgeting techniques are useful in investment decisions. Capital budgeting consists of several techniques such are Net present value, Profitabile index, Payback period, Discounted payback period, Internal rate of return and accounting rate of return.

Net present value : is calculated by using below formula, Present value of future cash flows minus Original investment. This decision tool may not help for the project which is dividable as parts. Net present value consider all cash flows.

Profitabile index : is express profitability for the each dollar investment. Calculated by using following formula, Present value of future cash flows dividend by original investment, this decision making useful for the project which are dividable as parts. Both Net present value and profitabile index are calculated based on estimated information rather than facts this is main disadvantage.

Payback period is also known as cash pay back period, this technique gives the period (years) in which the investment is realized in cash. This decision making ignores time value of money is most serious disadvantage.

Discounted pay back period, this is a particular period of time where discounted cash flows after tax and initial investment are equal. This technique consider the concept of time value of money. Discounted pay back period alone can not give proper decision making for the investment.