Project Budgeting and Viability Analysis

This assignment delves into the significance of project budgeting for firms. It examines various methods like Net Present Value (NPV), Payback Period, and Internal Rate of Return (IRR) to evaluate a hypothetical project's viability. The analysis includes calculating these metrics and interpreting their results in determining whether the project is financially sound and worth pursuing.

ACCOUNTING AND FINANCE

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
Part A...............................................................................................................................................3
Necessity to consider ethics in the capital budgeting..................................................................3
Part B...............................................................................................................................................4
Debt and equity ratio or capital structure....................................................................................4
Weighted average cost of capital.................................................................................................4
Part C...............................................................................................................................................6
(a)Payback period........................................................................................................................6
(b)Discounted payback period.....................................................................................................6
© Net present value method........................................................................................................7
(d)Profitability index...................................................................................................................8
(e)Internal rate of return method..................................................................................................8
CONCLUSION................................................................................................................................9
REFERENCES..............................................................................................................................10
Table 1Computation of cost of capital.............................................................................................4
Table 2Calcualtion of enterprise value............................................................................................4
Table 3Weighted average cost of capital.........................................................................................5
Table 4Calculation of payback period.............................................................................................6
Table 5Disocunted payback period.................................................................................................6

INTRODUCTION
Project heavily affect the business firm because implementation of same lead to revenue
generation in the business. In the current report necessity to consider ethics in the capital
budgeting process are explained in detail. Along with this, in the report calculation in respect to
estimation of cost of capital is performed by following specific model and on that basis discount
rate is estimated. At end of the report, project evaluation method is applied on the cash flows and
useful meanings are deduced on the basis of received results.
Part A
Necessity to consider ethics in the capital budgeting
Capital budgeting is the process under which project is evaluated by the business firm.
Under this method there are number of approaches that are used by the managers to evaluate the
project. Relevant methods are payback period, average rate of return, net present value and
internal rate of return method. There is specialty of all these project evaluation methods for the
business firms. It is very important to consider ethics in the use of capital budgeting method.
This is because in this approach one need to make projection of the cash flows and same are used
to measure the viability of the project (Bierman Jr and Smidt, 2012). It must be noted that for
making projection cash flows are estimated by making assumption about the growth rates. There
are number of stakeholders of the business firm and every firm main target is to create good
image among the stakeholders. Stakeholders makes investment in any business firm by
considering its cash flows that are estimated by the project managers. If there estimation will be
wrong then in that case stakeholders will make wrong investment decision in respect to the
business firm. Thus, it is necessary to consider ethics in the capital budgeting process. This is
because making of wrong projection lead to cheating with the shareholders. Thus, it is very
important follow ethics in the capital budgeting process because by making estimation of wrong
growth rate of cash flows situation is misunderstand by the investors and when they face loss
firm image tarnished among the them. This negatively affect the business firm.

Part B
Debt and equity ratio or capital structure
In the present time period capital securer ratio of proportion of debt and equity is 0.006
which is very low value of the mentioned ratio if compared with the other firm’s similar ratio.
From the annual report of the business firm it can be identified that. It can be observed that firm
share capital is 3.4 million in value and its long term loan is valued at 218586. It can be said that
firm capital structure is balanced as there is very low proportion of debt relative to equity in the
capital structure.
Weighted average cost of capital
Table 1Computation of cost of capital
CAPM Assumptions
Cost of equity 7.00%
Risk free rate of return 3.0%
Beta 0.50
Return on market 8%
Table 2Calcualtion of enterprise value
Enterprise
Value (EV)
Current Market
Price 0.031
Shares issued
109,67
7,419
Market value of
the firm
3,4
00,000
Loan: Long term
loan 218,586
Less: Cash &
Cash Equivalents 261,678

Enterprise Value
3,3
56,908
Table 3Weighted average cost of capital
Debt Equity
Weightage
Proportion of
equity in the capital
structure 93.96%
Proportion of debt
in the capital
structure 6.04%
Rate of interest 12%
Tax rate 30%
Weighted average
cost of capital
Weighted
average cost of
capital 7.08%
Interpretation
Weighted average cost of capital refers to the weight of equity and debt in the capital
structure. Equity weight refers to the proportion of equity in the capital structure. Equity
proportion is 93.96% which reflects that portion of equity is high in the capital structure. On
other hand, portion of debt is 6.04% which indicate that portion of debt is low in the capital
structure. By considering both 7.08% as cost of capital is computed.

Part C
(a)Payback period
Table 4Calculation of payback period
Project
Initial
investment -54200
1 20608 -33592
2 20608 -12984
3 20608 7624
4 20608 28232
5 33808 62040
Interpretation
Payback period is the one of the main method that indicate the duration and extent to
which time is taken by the project to cover the investment amount (Lozano, Villa and Canca,
2011). Values of calculation reflects that investment can be covered in the project in two years.
Thus, it can be said that project is viable for the firm.
(b)Discounted payback period
Table 5Disocunted payback period
Initial
investment
Project -54200
1 17920 -36280
2 15583 -20697
3 13550 -7147
4 11783 4635
5 16809 21444
Interpretation
Discounted payback period is the approach under which cash flows of the project are
discounted and in this way viability of the project is measured. Mentioned method reflects that

project investment amount can be covered in the three year time period (Hall and Millard, 2010).
Hence, it can be said that project is viable.
© Net present value method
Figure 1Calculation of net present value method
Interpretation
Net present value is the one of the most important method that is used for measuring the
viability of the project (What is capital budgeting, 2017). It can be seen from the table that NPV
of project is high 21444 which means that project is profitable for the firm. Thus, in the basis of
this parameter it can be said that project is viable for the firm.

(d)Profitability index
Figure 2Profutability index
Interpretation
Profitability index is one that reflects the ratio under which prevent value summation is
divided by the initial investment (Benninga, 2010). It can be seen from the table that profitability
ratio value1.39 which means that for each investment amount cash flow value on per unit of
investment amount is 1.39. It can be said that project is viable for the firm.
(e)Internal rate of return method
Figure 3Calculation of internal rate of return

Interpretation
Internal rate of return reflects that return that can be earned on the project. It can be seen
from the table that IRR of the project is 25.59% (Taha, 2014). It can be said that at least
moderate return is generated by the project and on this basis it can be considered viable for the
firm.
CONCLUSION
On the basis of above discussion it is concluded that is great significance of the project
budgeting method for the business firms. This is because by using same decisions are taken by
the managers in better way. It is very important to follow ethics in the business because by doing
so it can be ensured that cash flows will be estimated in proper manner and viability of project
will be measured in proper manner. Discount rate must be estimated by considering weighted
average cost of capital method and value of same must be used to measure the viability of the
project. It can be said that by using project evaluation method better decisions can be made by
the managers.