FIN200 Business Finance: Capital Budgeting & Investment Analysis

This essay provides a detailed explanation of capital budgeting, focusing on sensitivity analysis and scenario analysis as crucial tools for investment decision-making. It discusses the importance of capital budgeting in evaluating long-term investment opportunities, highlighting the risks involved and the significance of techniques like Net Present Value (NPV) and Internal Rate of Return (IRR). The essay further elaborates on sensitivity analysis as a method for assessing the impact of varying independent variables on dependent variables, emphasizing its role in identifying key variables and evaluating potential undesirable outcomes. Additionally, the essay explores scenario analysis, detailing its application in evaluating situations involving major market shifts and changes in business conditions, using base case, best case, and worst-case scenarios to provide a comprehensive understanding of potential consequences. Finally, it includes an analysis of a project based on provided financial data, concluding on whether the project is viable based on NPV, IRR, and payback period criteria. This document is available on Desklib, a platform offering a wide range of study resources, including past papers and solved assignments, to support students' academic needs.

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Table of Contents
Question 1..................................................................................................................................2
Question 2..................................................................................................................................5
Reference....................................................................................................................................6

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Question 1
Capital budgeting is the procedure for evaluating the long term alternative
investments and deciding upon which asset is to be sold or purchased. Decision of capital
budgeting requires the careful analysis as they are generally most risky and difficult decisions
those are taken by the managers (Kengatharan, 2018). Particularly, the capital budgeting
decisions is considered as risky as – (i) the outcome is not certain (ii) usually large amount of
money involved (iii) investments involves the commitment for long-term (iv) decision can be
difficult or may not be possible to reverse irrespective of how poor the outcomes turned to be.
Risk is specifically high for the technology related investments owing to uncertainty and
innovations. Different techniques used for analysing investment projects are net present value
(NPV) and internal rate of return (IRR) (Hayward et al., 2017). NPV approach applies time
value of money to the future cash flows and the cash outflows which in turn enable the
management to analyse the benefit and cost of a project at one point of the time. It is
computed through discounting of the future cash flows at the required rate of return and
subtracting the initial investment amount from that. If the NPV of any project is positive the
project is accepted otherwise it is rejected. On the other hand, the IRR approach is used by
the corporations for comparing and deciding among the capital projects. IRR is interest rate
that brings the series of cash flows to the NPV of nil. Using the discounted cash flows for
computing IRR is known as discounted cash flow (DCF) method of analysis. When the IRR
is used to evaluate any project the IRR is compared to the predetermined hurdle rate that is
the cost of capital. The project to be acceptable, its IRR shall be more than the cost of capital
of the company (Eldenburg et al., 2016).
Sensitivity analysis is the tool used under capital budgeting for evaluating how
different values from set of the independent variables have an impact on specific dependent

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variables under particular conditions. Generally, the sensitivity analysis is used for wide
range of the fields, rages from NPV, IRR and investment project evaluation. It is also known
as the what-if analysis or what – if simulation exercise is widely used in the financial analysis
for predicting outcome of the specific action while performed under specific conditions.
However, the main purpose of it is not to quantify risk but to establish how IRR and NPV is
sensitive towards changes in the key variables when the investment projects are evaluated.
Most often the undesirable alterations are taken into account in sensitivity analysis.
Objectives of analysis are – (i) identifying key variables that may have impact on the cost of
the project and the series of benefits (ii) examining the results for expected undesirable
results in key variables (iii) evaluating the impact on project decisions owing to such changes
(iv) recognizing action that nay be taken to eliminate the impact of undesirable changes on
the project. However, the sensitivity analysis requires that it shall be carried on in systematic
approach (Iooss & Lemaître, 2015). For fulfilling the above mentioned criteria the steps to be
followed are – (i) identifying key variables with which project decision are sensitive (ii)
measuring the effect of projected alterations for variable with regard to the base case for IRR
and NPV and thereby calculating the indicator for sensitivity and changes with changing the
values (iii) taking into account the expected combination for the variables those are
simultaneously expected to be changed and provide undesirable outcomes (iv) evaluating the
direction as well as the level of likely alterations for the key variables identified involving
the recognition of source of alterations (Winfree et al., 2018).
On the other hand, the scenario analysis requires financial analyst to depict the
specific scenario with details. Usually the scenario analysis is carried out for evaluating the
situations that involves major shocks like shift in the global market or any major changes in
business. In capital budgeting, the scenario analysis lists the entire input series and evaluates
the changes in the input value for each scenario (Liu et al., 2015). Scenario analysis is

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intended to analyse the consequences of action under different set of factors. For example, the
analysis provides how NPV or IRR of the investment project will be different under high
inflation and under low inflation (Chittenden & Derregia, 2015). However, the scenarios
must be feasible to provide accurate image of consequences. Generally, the scenario analysis
applies 3 scenarios. These are the base case scenario, the best case scenario and the worst
case scenario. Base case is considered as the projected scenario where if all the things
proceed in normal way the result will be as projection. However, the under worst case
scenario and the best case scenarios are with less and more desirable conditions and are
limited by feasibility sense. However, after specifying scenario details the analyst specifies
all variables which in turn enable to align with scenarios (Lim et al., 2018). Objective of the
scenario analysis is not to recognise the accurate circumstance for each scenario but to
approximately recognise them to deliver the probable idea for what may take place or turn
out.

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Question 2
From the above table it can be noticed that the NPV of the project is in positive that is
$15,80,737.80. IRR of the project is 16.72% that is more that the cost of capital of 10%.
Discounted payback period is 4.29 years and simple payback period is 3.49 years. Both
simple as well as discounted payback period is less than 5 years that is the project’s useful
life. Further, it is found that the PI of the projects is more than 1 that is 1.20. Hence, from all
the aspect the project is expected to generate profit for Berry Mount. Therefore, the project
shall be accepted (Eldenburg et al., 2016).

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Reference
Chittenden, F. & Derregia, M., (2015). Uncertainty, irreversibility and the use of ‘rules of
thumb’in capital budgeting. The British Accounting Review, 47(3), pp.225-236.
Eldenburg, L. G., A. Brooks, J. Oliver, G. Vesty, R. Dormer and V. Murthy (2016).
Management Accounting, 3rd Edition, Wiley, Brisbane, Australia.
Hayward, M., Caldwell, A., Steen, J., Gow, D. & Liesch, P., (2017). Entrepreneurs’ capital
budgeting orientations and innovation outputs: Evidence from Australian
biotechnology firms. Long Range Planning, 50(2), pp.121-133.
Iooss, B. & Lemaître, P., (2015). A review on global sensitivity analysis methods.
In Uncertainty management in simulation-optimization of complex systems (pp. 101-
122). Springer, Boston, MA.
Kengatharan, L. (2018). Capital Budgeting Theory and Practice: A review and agenda for
future research. American Journal of Economics and Business Management, 1(1), 20-
53.
Lim, C., Teng, S.G., Al-Ghandour, M. & Bowen, F.H., (2018). Let Scheduling for Funding
Scenario Analysis of Highway Construction Projects With a Case of NCDOT. IEEE
Transactions on Engineering Management.
Liu, M., Balali, V., Wei, H. H., & Peña-Mora, F. A. (2015). Scenario-based multi-criteria
prioritization framework for urban transportation projects. American Journal of Civil
Engineering and Architecture, 3(6), 193-199.

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Winfree, J.A., Rosentraub, M.S., Mills, B.M. & Zondlak, M.P., (2018). Capital Budgeting
and Team Investments. In Sports Finance and Management (pp. 343-374). Taylor &
Francis.