Capital Budgeting: Techniques and Analysis

Running head: BUSINESS FINANCE
Business finance
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1BUSINESS FINANCE
Table of Contents
Question 1..................................................................................................................................2
Question 2..................................................................................................................................5
Reference....................................................................................................................................6

2BUSINESS FINANCE
Question 1
Capital budgeting is the procedure for evaluating the long term alternative
investments and deciding upon which asset is to be sold or purchased. Decision of capital
budgeting requires the careful analysis as they are generally most risky and difficult decisions
those are taken by the managers (Kengatharan, 2018). Particularly, the capital budgeting
decisions is considered as risky as – (i) the outcome is not certain (ii) usually large amount of
money involved (iii) investments involves the commitment for long-term (iv) decision can be
difficult or may not be possible to reverse irrespective of how poor the outcomes turned to be.
Risk is specifically high for the technology related investments owing to uncertainty and
innovations. Different techniques used for analysing investment projects are net present value
(NPV) and internal rate of return (IRR) (Hayward et al., 2017). NPV approach applies time
value of money to the future cash flows and the cash outflows which in turn enable the
management to analyse the benefit and cost of a project at one point of the time. It is
computed through discounting of the future cash flows at the required rate of return and
subtracting the initial investment amount from that. If the NPV of any project is positive the
project is accepted otherwise it is rejected. On the other hand, the IRR approach is used by
the corporations for comparing and deciding among the capital projects. IRR is interest rate
that brings the series of cash flows to the NPV of nil. Using the discounted cash flows for
computing IRR is known as discounted cash flow (DCF) method of analysis. When the IRR
is used to evaluate any project the IRR is compared to the predetermined hurdle rate that is
the cost of capital. The project to be acceptable, its IRR shall be more than the cost of capital
of the company (Eldenburg et al., 2016).
Sensitivity analysis is the tool used under capital budgeting for evaluating how
different values from set of the independent variables have an impact on specific dependent