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

Capital budgeting is a process through which the company decides whether by taking up a long-term project any project is adding value to the shareholders or not. There are different types of capital budgeting technique used by companies like NPV method, IRR, Payback period and discounted cash flow period and these methods have been around for some time but in recent years companies have used advance software to use and analyses the viability of a project from different stand point like monte Carlo simulation technique, here you can see at different discount rates as to how much value is being added by the project, it gives the management a certain level of confidence that even if the project did not do very well, still it would add some value. The companies instead of using a single cash flow estimation, they have actually started to attach probability to each cash flow occurring, it gives them flexibility as to how much each cash flow can differ and to what extent we can be sure about that. The simulation method has been very useful in analyzing the project expected cash flow. The impact of these budgeting technique has been so far positive because with monte Carlo simulation a project NPV can be calculated at different rates and see how much value is added at different discount rates. It actually enhances the evaluation process of the project where you can evaluate a project more efficiently. With these techniques and software, the time taken to complete the process has also been reduces significantly. The resources used in the process can be used somewhere else.