Question

When negotiating the execution of an acquisition, what capital budgeting tools would you utilize to ensure you are getting the most value for your organization?

Answer 1

Various capital budgeting tools which are used to evaluate the profitability of the proposed acquisition are Net present value, Internal rate of return, benefit cost ratios are used to evaluate the proposal to get the most value for the organization.

Net present value is a tool of capital budgeting which measures the profitability of project in present value term. In NPV method, present value of expected cash inflow are calculated (at a discount rate for a given level of risk) and difference in initial investment and present value of cash inflow is called Net present value. NPV of any proposed option refers to excess of benefits over the the cost in present terms so a higher NPV is always preferred.

IRR stands for internal rate of return and it is the rate at which present value of future cash inflows would be equal to present value of cash outflows. It is a rate at which NPV is zero so if IRR is greater than MARR than project would be accepted.

profitability index or benefit cost ratio is another method which is used to measure the profitability of proposed options. In this method benefits are measured in ratio form and a B/C ratio of 1 is considered good for the profitability point of view. it is calculated by dividing the preset value of cash inflow by present value of cash outflows.