IRR and NPV Analysis for Capital Budgeting Decision Making
Added on 2019-09-30
24 Pages5009 Words230 Views
Finance
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[Type text]Course Topics
2Course TopicsOverview Capital budgeting process as value addition budget, helps in evaluation and ranking in projectsinvestment. Intention behind every investment budgeting strategy is to facilitate higher return. Allocation of capital to several projects involves in planning and funding of cash. The proper decision making process helps an organization worth to investment to pursue business and capital expenditures in real assets means in new assets with the expectation, growth of organization more than one year. To understand every stage origanization need to go through them whether its of decision making knowledge, position establishment by using option pricing analysis and also discounted cash flow analysis. Usually different approaches compared the projects performance and one of the non discount methods are accounting rate of return and payback analysis. Decision makingUncertainty is the main reason in modern world decision making strategy. Proposed capital projects with management can take overall decisions and count the possible outcomes of existingmarket circulation. Decision tree implementation ensure that using different software’s like expert choice and decision pro to gain knowledge regarding decision. Decision tree provided trade included private trade building to help. Different opinions and ideas, group and team execution are much better due to decision tree. Option pricing
3Course TopicsUncertainty is an important factor while considering option pricing also. First stage provide knowledge through decision tree whereas second stage ascertain the option offered by customers where producing company have options to change according to suitable option for the project to go through. Options can be taken in various ways: postponement, alteration, changes etc. How torecognize the project with the options values organization need to manage capital projects. Financial management in accounting studies the present values of assets. Inflation is main cause to reduce the cost of asset over the useful life. Future perspective involves uncertainty and sunk cost of money recognized the respective time value of money.Discounted rate of return consists of net present value, IRR and profitability index. The key element decision making usually examine these method. The entire company go through the purpose only to generate profitability. Operating expenses involves in every sales and to increasethe performance in order to profit throughout the whole system obligated to pay this operating expenses. The primary component of capital budgeting is making proposal in order to maximize the growth for through put to operate favorably. Cost reduction is less important. (Andor, G., et al 2015)Spreadsheet is a way where expected cash flows information laid. Payback analysis decisions determined time period and revenue generation. Cash flows determination after tax consider in capital budgeting. Some risk involvement are in its adjustment. After considering decision tree knowledge for decision making and also options building for company’s projects. Different factors comprised its scope are as: 1)Compensate the risk engagement in projects2)Acknowledge the risk for foreign projects.
4Course Topics3)Adjustment in capital budgeting for expected results.Economic life of planning projects can evaluate through stages of capital budgeting whereas calculation is the another level to examine capital projects. DepreciationAssets including capital assets are associated with depreciation, estimated life of an asset helps tocalculate the depreciable value of asset. Depreciation is a non-cash item in cash flow statement. Application of depreciation deducted to measure taxes on project revenues payment and also added depreciation to bring cash flow.Working CapitalInvestment basic requirement is to increase working capital. New production consumes more working capital which often need stock and salaries to pay. Change in working capital means mainly leads to company’s project. End in project evaluation brought reverse mechanism in projects.Overhead:Moreover planned projects involved in allocated overheads to increase proportion often. There isno difference happens with nature of allocation. For relevancy of cost there is need to access the overhead implemented in respective project associated with more capital investment.Financing Costs:
5Course TopicsTo funding a capital project financing is needed. To cover additional cash flows need to plan the capital project in its best way double cost effect possibility eliminates due to financing cost deduction from it. Discount rates included in financing cost from our capital project.Capital budgeting decisions influenced by the different factors: Funding for the business projectCapital criteriaInvestment and replacement Government interventionEconomic life criteriaEngagement of risk Location of an organizationPredictions of market performancePerformance level of an organizationGeneration of favorable returnsTotal money involved in projects show the profit of firm. Once investment made in long capital project cannot be reversed, capital budgeting help and provide advice to decrease sunk cost and ignore the investment in non planned investment. Since companies should make decision properly. Profit earning capacity based always on investment decision the right decision impact on whole organization. Continuation of project needs large funding whereas retained earning canhelp in project investment. (Lane, K.,2015)
6Course Topics In capital budgeting capital rationing is a one of the where the funds require in larger proportion than the available resources for the investment. At this situation NPV is preferable because for wealth maximization selection of investment plan of NPV provide highest present value to shareholders value to increase.IntroductionCapital budgeting emphasize the planning of major project for the company’s long term investment strategy included machinery replacement, new product, new capital assets, projects regarding research and development. Capital budgeting also called as investment appraisal wherecapital expenditure plays an important role. Considering individual examples from every methods helps to access the conclusion. Some of the key terms used in capital budgeting are ATP stands for arbitrage pricing theory which is a usual theory carry asset pricing in financial management. Financial assets in various economic factors to conclude market practices in a linear function. MIRR stands for Modified Internal return measure investment in a attractive manner to solve the problem facing situation and used ranking in its process for different alternatives. Modified version of internal rate of return follow MIRR for rates variation. Major methods we already use such methods to overview capital budgeting and in detail in examples with proper defining definition of each methods. They are the integral techniques we often used to comes to conclusion whether to find present value of money or whether to execute planning inconsidering various rate of return with capital generation. Mutually exclusive projects comes to vary its existence using IRR and NPV. Mutually exclusive projects when seems having different life span, we can consider capital budgeting decision based on NPV Analysis or replacement
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