Capital Budgeting Methods and Applications
Added on 2020-03-23
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Running head: CORPORATE FINANCE MANAGEMENTCORPORATE FINANCE MANAGEMENTName of Student:Name of University:Author Note:
1CORPORATE FINANCE MANAGEMENTTABLE OF CONTENTSINTRODUCTION...........................................................................................................................2DISCUSSION:.................................................................................................................................2SENSITIVITY ANALYSIS........................................................................................................3BREAK EVEN ANALYSIS:......................................................................................................6SIMULATION TECHNIQUE.....................................................................................................8CONCLUSION................................................................................................................................9REFERENCE:...............................................................................................................................10
2CORPORATE FINANCE MANAGEMENTINTRODUCTION In the market economy, one of the important factors of economic growth is capitalaccumulation and investment of capital. One of the crucial conditions for any business entity toascertain viability, profitability and development of its own is the effectiveness of the investedcapital. Based on the long-term goals the firms have, they incorporate the decision of financingand investing (Daunfeldt and Hartwig 2014). The likely outcome of the investment made arealways concern of the business and the knowledge of such procured by them based on capitalbudgeting techniques and various analyses which are conducted prior the investments are beingmade.The paper gives an outlined discussion about the role and requirement of capitalbudgeting. It further discusses the concepts of sensitivity analysis, scenario analysis, break-evenanalysis and simulation technique and their applicability in helping the investing business bodyto procure knowledge about the expected outcome of their actions of investments.The paper is prepared based on the motive to show how such theoretical analyses conceptapplies to business decision-making process and to what extent it influences such decisionsDISCUSSION:In order to take any decision regarding investment, a business always needs to undertakecapital budgeting process that helps the business entity determine whether to take up theinvestment in certain projects. A business organization has to take decision regarding variousissues like installation of new machines, new plants, replacement of old machines, launchingnew products, research and development for new projects all of which requires funding through
3CORPORATE FINANCE MANAGEMENTthe capitalization structure of the firms. The capitalization source of the company includes debt,equity or retained earnings received by the companies (Dutta and Babbel 2014.). Capitalbudgeting is a technique that rightly tries to allocate resources for capital utilization andinvestment expenditure so that the firm is able to derive higher return from the investmentsmade and deliverance of higher payoffs to their shareholders. Important procedures or conceptsapplied in capital budgeting are:Accounting Rate of ReturnNet present ValueInternal Rate of ReturnProfitability IndexEquivalent Annual CostCapital budgeting is important to help a firm take decision regarding its investment decisionbut it is not the only component to be carried, as there are other analysis needs to be followedtoo. Some of them are sensitivity analysis, scenario analysis and break even analysis followed bystimulation techniques (Nas 2016).SENSITIVITY ANALYSISThe investment decision is exposed to many challenges regarding the strength weaknessof the project they are invested in. This further brings forth the associated risk factor that comesup in almost with every decision. To ensure effectiveness of the implementations, the set of risksassociated with any projects should be assessed. There comes the importance of sensitivityanalysis. It helps the investor attain additional insight about the decision made for incorporatingany investment (Damodaran 2016).. This is a technique that helps the business determine thedifference of the impact of independent variables on certain dependent variable under givenassumptions. The independent variables are used as input variable that specifies the boundaries
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