Capital Budgeting - Techniques and Methods

RUNNING HEAD: FINANCE
Capital Budgeting

Finance 2
Qualitative questions
Question 1
Net Present Value is one of the capital budgeting technique used for evaluating an investment
proposal. It is the most common and popular method which measures the profitability of a
project (Baker & English, 2011).
Internal rate of return is that rate which makes the NPV of all cash inflows of a project equals
to the cash outflow of that project. It is also used for determining the profitability factor.
It is assumed in modified IRR that the cash flows are reinvested at firm’s cost of capital and
firm’s finance cost is used for financing the initial outlay. The cost and profitability of the
proposal is more accurately measured by this method.
Payback period is basically the amount of time taken by a project to recoup its original
investment.
Discounted payback period is a method of calculating payback year by considering the
discounted cash flows of the project (Baker & English, 2011).
Advantages Disadvantages
NPV It measures the value created by
the investment for the company.
It is not suitable for the projects
having different sizes.
IRR It includes time value of money. It does not takes into account the
actual value of benefits.
MIRR It reinvested all the cash flows
and make them more realistic.
It has a potential conflict with NPV
method.