Capital Budgeting: Evaluating Long-Term Investments with APV & NPV

This essay provides an overview of capital budgeting, which is the process of planning long-term investments. It discusses key capital budgeting methods such as Adjusted Present Value (APV) and Net Present Value (NPV), highlighting the differences between them, particularly the consideration of equity and the use of different discount rates. The essay further explores other capital budgeting metrics like the Internal Rate of Return (IRR) and Discounted Cash Flow (DCF) method, explaining how each is used to evaluate the profitability and attractiveness of potential investments. The conclusion emphasizes the importance of capital budgeting in making informed decisions about long-term investment opportunities, such as new facilities, machinery, and construction projects.

Running head: CAPITAL BUDGETING
Capital Budgeting
University Name
Student Name
Authors’ Note

1CAPITAL BUDGETING
Table of Contents
Introduction................................................................................................................................2
Discussion..................................................................................................................................2
Conclusion..................................................................................................................................3
References..................................................................................................................................4

2CAPITAL BUDGETING
Introduction
The capital budgeting is the process of plan of the entities long term investments like
the machinery, replacements new plans and so on, which includes the projects research
development where finance is needed (Andor, Mohanty & Toth, 2015). The mechanism of
capital budgeting evaluates and determines the potential investments, thee are models of
capital budgeting that includes, net present value method, Internal rate of return method,
discounted cash flow method and payback period.
Discussion
The concept of APV
The process of APV which stands for the Average Present value is used for the
projects valuation of the company. In this mechanism the net present value is considered
along with the debt financing cost that includes the interest tax shields, insurance, cost of
debts and the financial subsidiaries (Chittenden & Derregia, 2015).
In other words the adjusted present value refers to the net present value of a company
or a project if it is funded totally by the equity and the present value of any financing
benefits, that are the extra impacts of debt.
The Differences between APV and NPV
There are few differences between the APV and NPV that can be pointed put which
includes the consideration of equity in case of APV that the NPV does not consider at the
time of calculation of the equation. The primary difference that lies between the APV and the
NPV is that the use of the cost of the cost of equity as the discount rate but in case of NPV
thee is the use if the WACC (Johnson & Pfeiffer, 2016). Moreover, the APV includes the Tax
shields like those which are provided by the interests that are deductible. Therefore, it can be

3CAPITAL BUDGETING
said that although the both capital budgeting methods are valid, and can give the required
result there are different sets of data that is used in order to determine the investment that will
yield the return on investment. It can be said that APV = NPV of the project assuming it is all
equity financed + NPV financing effects.
The two other models of capital budgeting other than NPV and APV
The two other capital budgeting metric other than NPV and APV that are identified are:
 Internal Rate of Return: The internal rate of return is the methodology that is used
in the process of capital budgeting where there is the estimation of the profitability of
the potential investments (Jagannathan, et al., 2017). The internal rate of return is the
rate of discount that is used to make the net present value of all cash flow from a
particular project equal to zero.
 Discounted Cash Flow method: The discounted cash flow is the capital budgeting
method that values the estimation of attractiveness of an opportunity of investment. In
this methodology the DCF evaluates the use of future free cash flow projections and
discounts them with the help of required annual rate, to arrive at present value
estimates (Hall & Sibanda, 2016). The DCF can also be termed as the model of
Discounted Cash Flow.
Conclusion
The metrics of Capital budgeting is largely used for the opportunities of long-term
investment whose tenure is more than a year and gives returns over the various subsequent
years. These investment opportunities could be for new, factory facility, plant & machinery
and construction of a building. Therefore, it can be said that the various models of Capital
budgeting is an essentially vital tool in finance when it comes to capital estimation.

4CAPITAL BUDGETING
References
Andor, G., Mohanty, S. K., & Toth, T. (2015). Capital budgeting practices: A survey of
Central and Eastern European firms. Emerging Markets Review, 23, 148-172.
Chittenden, F., & Derregia, M. (2015). Uncertainty, irreversibility and the use of ‘rules of
thumb’in capital budgeting. The British Accounting Review, 47(3), 225-236.
Hall, J. H., & Sibanda, T. (2016). Capital Budgeting Practices: An Empirical Study of Listed
Small en Medium Enterprises. Corporate Ownership & Control, 200.
Jagannathan, R., Matsa, D. A., Meier, I., & Tarhan, V. (2017). Search in. CFA Digest, 47(4).
Johnson, N. B., & Pfeiffer, T. (2016). Capital budgeting and divisional performance
measurement. Foundations and Trends® in Accounting, 10(1), 1-100.

5CAPITAL BUDGETING