Question

You are a Finance Manager for a major utility company.

Respond to the following in a minimum of 175 words:

• Think about some of the capital budgeting techniques you might use for some upcoming projects.
• Discuss at least 2 capital budgeting techniques and how your company can benefit from the use of these tools.
• Compare your approaches to other students’ responses. How were they similar or different? Why might you use the different approaches shared by your classmates?

Answer 1

Diff Capital Budgeting Techniques:

1. Payback period:

Payback period is the period in which initial investment is recovered.
If Actual PBP > Expected PBP - Project will be rejected
Actual PBP </= Expected PBP - Project will be accepted

It ignores the Cash Flows after PBP and Time Value of Money

2. Discounted Payback period:
Discounted Payback period is the period in which initial investment is recovered after considering the time value of money.
If Actual disc PBP > Expected disc PBP - Project will be rejected
Actual disc PBP </= Expected disc PBP - Project will be accepted

It ignores the Cash Flows after PBP but considers Time Value of Money.

3. NPV :
NPV = PV of Cash Inflows - PV of Cash Outflows
If NPV > 0 , Project can be accepted
NPV = 0 , Indifference point. Project can be accepted/ Rejected.
NPV < 0 , Project will be rejected.

4. IRR :
IRR is the Rate at which PV of Cash Inflows are equal to PV of Cash Outflows.
It assumes that intermediary Cfs are reinvested at IRR only.

If IRR > Cost of Capital - Project can be accepted
IRR = Cost of Capital - Indifferebce Point - Project will be accepted / Rejected
IRR < Cost of Capital - Project will be erejected

5. Modified IRR:

It is similar to IRR. In IRR, we are assumed that intermediary cashflows are reinvested at IRR only. In MIRR, we assume that Intermediary CFs are reinvested at
Reinvestment Rate rather than at IRR.

6. Profitability Index:

PI = PV of Cash inflows / PV of Cash Outflows
If PI > 1, Project will be accepted,
PI = 1, Indifference point. Project will be accepted/ Rejected.
PI < 1, Project will be rejected.

Same are less all methods other than PBP & Disc PBP suggests same decisions except in some cases. In such cases, it is advicable to select the project based on NPV.