Financial Information and Risk Methodologies in Capital Budgeting

This presentation discusses the importance of financial information and risk methodologies in capital budgeting. It covers the computation of NPV and IRR, the requirement of further financial information, and the application of financial information in other situations. It also highlights the various risks that should be considered while evaluating capital budgeting decisions. The presentation includes references from various sources such as Harvard Business Review and Springer Science & Business Media.

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As per the given information IRR
and NPV of the project is
computed for analyzing the
acceptability of the project.
However, payback period is not
taken into consideration.
Payback period is the time in
which the initial investment
amount of the project is
recovered. Payback period is
considered as major
determinant while evaluating
the acceptability of any project.
Sufficient financial information for making solid decision –

Requirement of further financial information -
The financial information those were provided
were as follows –
 Initial outlay for the project amounting to $
40 million that included $ 35 million for the
equipment and $ 5 million for the net working
capital
 Life of the equipment as well as the project is
5 years
 Sales will be $ 27 million each year for 5
years
 Gross margin rate will be 50% without
considering depreciation
 Depreciation for tax purposes will be
provided on straight line basis
 Administrative, selling and general expenses
will be 10% of sales
 Rate of tax is 35% and weighted average cost

Financial information used as determinant for decision -
Financial figure those determined the
acceptability of the project were the
NPV and IRR. Rejection of coffee
packaging project was taken based on
the computation and result of NPV and
IRR. As per the computation the NPV of
the project is - $ 996,642.68. The
negative NPV is indicating that the
discounted cash inflows of the project
over the lifetime of the project that is
for 5 years are lower as compared to its
initial investment that is $ 40 million.
While NPV is considered for taking
decision regarding acceptance of any
project the project is not accepted if
the NPV of the project is negative.

Applying financial information in other situations –
Financial information provided in the
task can be used for other situations
like computing the payback period of
the project. Payback period is the
time in which the initial investment of
the project can be recovered.
Therefore, if the investor requires the
money in short term period or the
investor has preference regarding the
period in which he wants the money
payback period of the project will be
computed with the help of the given
information.

Risk methodologies in capital budgeting –
Capital budgeting process shall take into
consideration various risks those are faced
by the companies and its managers. Risk
is potential that an activity or chosen
action will result into loss. Various risks
those shall be considered while
considering the capital budgeting are –
 Corporate risk
 Industry – specific risk
 Stand – alone risk
 Market risk
 International risk
 Project – specific risk

References
Chandra, P. (2017). Investment analysis and portfolio management.
McGraw-Hill Education.
DeFusco, R. A., McLeavey, D. W., Pinto, J. E., Anson, M. J., & Runkle,
D. E. (2015). Quantitative investment analysis. John Wiley & Sons.
Gallo, A. (2014). A refresher on net present value. Harvard Business
Review, 19.
Gallo, A. (2016). A refresher on internal rate of return. Harvard
Business Review Digital Articles, 2-4.
Gorshkov, A. S., Rymkevich, P. P., Nemova, D. V., & Vatin, N. I.
(2014). Method of calculating the payback period of investment for
renovation of building facades. Stroitel'stvo Unikal'nyh Zdanij i
Sooruzenij, (2), 82.
Guerard Jr, J. B. (2013). Introduction to financial forecasting in
investment analysis. Springer Science & Business Media.
McAuliffe, R. E. (2015). Internal Rate of Return. Wiley Encyclopedia
of Management, 1-1.
Žižlavský, O. (2014). Net present value approach: method for
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Behavioral Sciences, 156, 506-512.