FIN200 Report On Capital Budgeting Decision Making

Added on -2020-02-19

| FIN200| 9 pages| 2706 words| 105 views

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CAPITAL BUDGETING
INTRODUCTIONDecisions are to be taken for many things in the company the matter can be major or minor.The responsibility of decision making lies in the hands of the management. The managementis wholly responsible for the results of that decision making. Some of the examples wheredecision making is required are acceptance or repentance of a special order, investmentdecision, borrowing decision etc (Berman, Knight and Case, n.d.)..We know that a company cannot survive without funds, whether small in nature or big.Therefore, it is important to carry out proper financial planning. A company needs severalassets in order to grow, expand and earn profits but before investing in such asset it isimportant to know whether it is worth funding cash for these or not. This decision can betaken with the help of a method known as capital budgeting (Bruner, Eades and Schill, 2017).Capital budgeting plays a major role in financial planning and therefore, it has its ownimportance. The importance of capital budgeting are (TULSIAN, 2016)-1.This process helps to forecast the future cash inflows and outflows of a companywhich further helps to decide about the acceptance of a particular project.2.The process of decision making is carried out at all the levels of the organisation andthis process begins when there is an idea of a new project till this project is concluded.Hence, it is required at every time of the company’s working.3.A company can grow, expand and compete well only when it has the ability todevelop long term strategic goals. However, capital budgeting is a process which ishelpful in setting these goals.4.There are huge expenditures incurred in a company but it is always important tomonitor and analyse the benefits of spending funds, this becomes easier with the helpof the capital budgeting expenditure.Capital budgeting is used by many companies as it is beneficial in taking long termdecisions. However, this process also has certain limitation which a company shouldknow before its adoption (Clarke and Clarke, 1990)-1.Markets are dynamic in nature; therefore we can never now about the risk anduncertainty that may arise. Capital budgeting ignore the risk element and theuncertainty element (Fairhurst, 2015).2.Capital budgeting takes into consideration certain financial factor, it complete ignorethe non quantifiable factor such as reputation of the company, employee morale etc.3. There is no guarantee that the decision taken through this process will be correctbecause capital budgeting is a process which takes future into consideration and noone is capable enough to predict the future (Taylor, 2008).4.The capital investment decisions can also be limited by urgency.Capital budgeting involves various methods and techniques. Firstly, let us nowunderstand the method involved in capital budgeting-
1.Net present value- The value that is attained after deducting the cash inflows from thecash outflows is known as net present value. This formula helps to know whetherthere will be profitability or not and to what extent. A company thinks of acceptingthe offer when the NPV calculated is positive.Example of NPV-ProjectA YearCashFlow0-90000125000224000326000427000530000Required rate of Return 12%NPV ofProject AYearCashFlowPresent Value of Cash Flows0-90000 -90,000 12500022,321 22400019,133 32600018,506 42700017,159 53000017,023 NPV4,142 NPV of Project BYearCash FlowPresent Value of Cash Flows0-90000-90000Project BYearCash Flow0-900001 -2 -3 -475000580000

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