Analysis of Capital Budgeting and Corporate Decision Making Process

This report delves into the core concepts of capital budgeting and its role in corporate decision-making. It explores various investment appraisal techniques, including sensitivity analysis, which assesses how changes in independent variables impact project outcomes. Scenario analysis is also examined, offering a method to evaluate investment projects under different conditions by considering multiple variables. Furthermore, the report covers break-even analysis, a tool for determining the point at which revenue equals total costs, aiding in the evaluation of investment proposals. Finally, the report discusses simulation techniques, specifically the Monte Carlo simulation, which combines sensitivity and probability distributions to provide decision-makers with a probability distribution of net present value rather than a single estimate. The report concludes by highlighting the importance of these techniques in evaluating investment opportunities and making sound financial decisions. This report is designed to assist students with their understanding of finance and accounting principles and is available on Desklib, a platform for AI-powered study tools.

Running Head: Corporate Accounting
1
Project Report: Corporate Accounting

Corporate Accounting
2
Contents
Introduction.......................................................................................................................3
Sensitivity analysis...........................................................................................................4
Scenario analysis..............................................................................................................5
Break even analysis..........................................................................................................7
Simulation techniques.......................................................................................................9
Conclusion......................................................................................................................10
References.......................................................................................................................12

Corporate Accounting
3
Introduction:
This report has been prepared to identify the capital budgeting and the corporate
decision making process in an organization. Investment appraisal technique i.e. capital
budgeting is a process where various investments are analyzed on the basis of many variables
to find out the best investment opportunity for an organization. Basically, long term
investment opportunities are evaluated into capital budgeting techniques. These techniques
are helpful for the company to manage the various factors and it looks over the various
factors such as the PV factor, return, cash outflow, cash inflow etc. It has been observed that
the long term investment could be various investment proposals such as diversification of
market, buy new machineries, new plants, replacement of new machineries, various research
development projects, new products and services into the market etc. it has been found that
for conducting various tools to analyze the best investment proposal, an organization can take
the help of sensitivity analysis, scenario analysis, break even analysis, simulation technique
analysis (Damodaran, 2011).
Every organization wants to invest in a project which offers them maximum return in
less investment as well as the associated risk is also lower in that case. For a better project,
companies are required to look over the investment and then choose a best tool accordingly.
Such as if company wants to earn a specific amount after a period of time, than company
must go for scenario analysis as well as if the company wants to reach over a point where the
cost is equal to the revenue than company must choose the breakeven analysis as a technique
to opt the best available project (Barlow, 2006). This report will brief the user about the
sensitivity analysis, scenario analysis, break even analysis, simulation technique analysis and
their process and the situation where all of these tools could be used by the company to
analyze the best result.

Corporate Accounting
4
Sensitivity analysis:
Firstly, sensitivity analysis has been studied as a tool of capital budgeting technique to
make a better corporate decision for the goodness of the company. Sensitivity analysis is an
instrument which is used by companies to estimate that how several expanded values of an
independent variable could be affected by a detailed variable that has been calculated through
many assumptions by the managers. “What if” analysis is the other name of this technique.
Normally, entire quantitative aspect of an investment proposal such as cash inflow, cost of
capital, cash outflow, project duration, discount rate etc are predictable with an assurance.
But in fact, these things rarely take place (Lumby & Jones, 2007). This analysis assists the
companies to defeat the same difficulty of assumptions. The sensitivity analysis techniques
could be useful over diverse planning actions and not only upon the capital budgeting
corporate decision.
Sensitivity analysis assists an association into making the calculations that how the
allocation of probable IRR and NPV for an investment proposal under few circumstance is
impacted subsequently in a company to make an alteration into a sole variable which is
reliant in scenery. This sensitivity analysis could occur only be altering into single variable at
a time period. Sensitivity analysis calculates a rate for every variable and proposes a decision
making procedure to the corporation to decide the best investment project (Moles, Parrino &
Kidwekk, 2011). For instance, if the selling price of a product would be deducted by 20% and
consequently, the IRR would also be distorted due to some changes in the life of the project
to 5 years from 3 years. Thus this analysis assists the company to take superior decision about
proposal of investment.
According to the above instance, every aspect would be altered due to various
changes into a particular variable of the proposal. For instance, the changes which have been

Corporate Accounting
5
happened into the selling price would change the Net present value of the investment project
and the project’s total life would make a collision over the IRR. Then the estimated NPV has
been drafted into a graph to express about the sensitivity of the NPV which could take place
due to various changes in the aspects (Tsanakas & Millossovich, 2016). The below graph
express that the slope of NPV in the below chart express about the sensitivity of net present
value which is occurred due to make some variations into every input. The sharp the slope
will be, the more the sensitivity of net present value will be to create modifications into the
variable.
(Seitzinger et al, 2010)
Companies widely use this technique because this technique is quite simple and this
focuses over many related estimates. Mainly this technique is helpful for the companies to
make decision related to the finance aspects.
Scenario analysis:
Scenario analysis has been studied as a tool of capital budgeting technique to make a
better corporate decision for the goodness of the company. Sensitivity analysis is widely used
as a technique of risk analysis but this study had some limits. Conversely, sensitivity analysis

Corporate Accounting
6
is supreme to contact with a variety of probability distributions of numerous inputs.
Additionally, scenario analysis also helps the company to combine more variables so that the
united effect might be investigated too with the alteration in more than 1 variable (Bierman
and Smidt, 2012).
The scenario analysis provides a detailed answer of particular issues. Mainly, scenario
analysis answers the problem that how terrible could an investment project look. Multiple
times, companies just make an assumption about the factors and then they forget to take other
assumptions according to the previous assumption and the rival’s relation and environmental
and economy consideration etc. In this analysis; various factors are measured according to
this scenario analysis which could be made by the companies. These factors could array from
economical state to the rivalry’s response over any action of the company. Further, the
components calculate the number for every factor in scenario analysis. Essentially, best,
average and worst, these three scenarios are considered in the scenario analysis to make a
best decision about the investment proposal (Garrison et al, 2010). Though, it has been
observed that the long range could be varied. The next component of this analysis is to make
a focus over various critical aspects and make a scenario for each factor. And at the end, each
scenario’s probabilities are calculated. This scenario might be based upon various macro
factors like exchange rate, interest rate and numerous micro factors like reaction of
competitor.
Factors Normal case Best case Worst case
Yield - + 10 % 20%
Exchange rate - + 10 % 10%

Corporate Accounting
7
Transportation
cost
- -5% +20%
Marketing cost - -5% +20%
Sales cost - + 10 % 20%
Sales price 1.03 1.05 1.00
Cash inflow 17 % 29 % 1 %
NPV 1 2.2 -2.7
(Burns and Walker, 2015)
Through the above table, it has been found that the above three scenarios are
presented there for each investment project in the company. Through this scenario analysis, it
has been observed that the 3 scenarios are obtainable in the company that are average, best
and worst. Through this technique, it becomes quite easy for the companies to choose the
better investment project.
Break even analysis:
Breakeven analysis assists an association into choosing the best proposal according to
the associated cost and revenue association. In this technique, numerous tools of a project of
investment are evaluated and then the breakeven level is investigated. An investment
project’s breakeven level is a point where the revenue earned by the firm is equal to the total
associated cost. In this analysis, a chart is plotted and in that chart, the cost slope and the total

Corporate Accounting
8
revenue slope are drawn (Grant, 2016). The interaction point is the breakeven point where
both the slopes cut too each other. Break even analysis creates an idea regarding the
optimistic return from a proposal of investment. This breakeven analysis express that a
project’s fixed cost is not directly connected with the production level of the project and
hence the breakeven level get affected through the project’s fixed cost. In addition, it has
been found that a project’s variable cost directly make an alteration into the total volume of
output.
Breakeven analysis study is an immense tool to recognize the association between the
variable cost, returns and the fixed cost. Breakeven point provides an idea about the positive
return from an investment proposal and it also express the worth of chart and mathematical
calculation for this study (Shim, Siegel and Shim, 2011). This analysis assists an organization
in estimating the level of manufacture through that the positive returns might be received by
the firm. And the whole cost could be calculated properly.
(Wright et al, 2010)
The above breakeven point chart depict that the total 20 units are needed by the
company to be manufactured to cover entire cost. Additionally, this much of manufacturing
would assist the firm to make more profits. These estimations are helpful for the company to

Corporate Accounting
9
recognize the best obtainable project in the marketplace. And this study also assists the
corporation to decide the return which may be received by the corporation after investing into
a particular project. Additionally, it has been found that how much price would be rewarded
by the corporation even in the concern of no production. Further, how many units are needed
by the firm to produce units to reach over the breakeven point where the revenues and cost
are equivalent.
Simulation techniques:
This study is also recognized as Monte Carlo simulation technique. It binds sensitivity
and probability distribution jointly. This method of simulations is based upon different
mathematical computations. The main essential request of this method is to offer judgment
makers assistance along with the net present value’s probability distribution rather than a
single judgment about the approximate NPV. This technique binds all the associated factors
and then takes a decision about the numerous investment opportunities.
In this analysis, firstly, a simulation implement process takes place to examine over
the proposal and then various associated key factors which are concerned to approximate the
exaggerated project and the inter relationship of that project with various other factors
(Gervais, Heaton and Odean, 2011). This technique engages into modelling of cash outflow
and inflow to divulge entire key aspects which are predisposed by cash payments as well as
receipts and their association with other aspects.
Simulation technique engages the association of NPV with different limits and
exogenous variables. This technique specifies the probability distribution and limit value of
exogenous variables. Additionally, a value is chose erratically from probability distribution
over every exogenous value (Burns and Walker, 2015). Adding up, NPV is calculated by
corresponding over random generated value of pre specified variables and variables of

Corporate Accounting
10
parameters. More, the 3rd and 4th procedures are repeated over again to get a huge number of
simulated NPV. Lastly, in the graph, probability distribution slope is plotted and standard
deviation and mean of returns are calculated to assemble the risk level.
This technique is analyzed to decide the top investment project from various available
projects. Mainly, this analysis depicts its unease about the sensitivity analysis and probability
distribution. This study assists the company to identify and assess the best available proposal
from the available projects (Bodie, 2013). This analysis helps the company to assess the best
plan for the company in context of the profits. Simulation technique is a technique which is
mostly uses by the organization to make a better decision about various investments which
are the total time period in which company would be capable to repeal the entire cost.
Conclusion:
Through the above study, corporate decision making process in capital budgeting has
been analyzed and it has been analyzed that the procedure is used by the company to
calculate the numerous available opportunities to identify the best project from market. The
technique of capital budgeting identifies the numerous projects according to their present
value factors, cash flows, internal rate of return, accounting rate of return etc. for this study, it
has been found that for conducting various tools to analyze the best investment proposal, an
organization can take the help of sensitivity analysis, scenario analysis, break even analysis,
simulation technique analysis.
Sensitivity analysis is an instrument which is used by companies to estimate that how
several expanded values of a independent variable which would affect by a detailed variable
that has been calculated through many assumptions by the managers. Scenario analysis
answers the problem that how terrible could an investment project look. Multiple times,
companies just make an assumption about the factors and then they forget to take other

Corporate Accounting
11
assumptions according to the previous assumption and the rival’s relation and environmental
and economy consideration etc. Breakeven analysis assists an association into choosing the
best proposal according to the associated cost and revenue association. In this technique,
numerous tools of a project of investment are evaluated and then the breakeven level is
investigated. And the main essential request of simulation method is to offer judgment
makers assistance along with the net present value’s probability distribution rather than a
single judgment about the approximate NPV. This technique binds all the associated factors
and then takes a decision about the numerous investment opportunities.
Thus through this study, it has been recognized that every risk analysis technique is
best at their own way and helps the organization into various different situations.

Corporate Accounting
12
References:
Barlow.J.F.,2006, Excel models for business and operations management, 2nd edition, John
Wiley & sons ltd, England
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge
Bodie, Z., 2013. Investments. McGraw-Hill.
Burns, R. and Walker, J., 2015. Capital budgeting surveys: the future is now.
Damodaran, A, 2011, Applied corporate finance,3rd edition, John Wiley & sons, USA
Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial
accounting. Issues in Accounting Education, 25(4), pp.792-793.
Gervais, S., Heaton, J.B. and Odean, T., 2011. Overconfidence, compensation contracts, and
capital budgeting. The Journal of Finance, 66(5), pp.1735-1777.
Grant, R.M., 2016. Contemporary Strategy Analysis Text Only. John Wiley & Sons.
Lumby,S & Jones,C,.2007, Corporate finance theory & practice, 7th edition, Thomson,
London
Moles, P. Parrino, R & Kidwekk, D,.2011, Corporate finance, European edition, John Wiley
&sons, United Kingdom
Seitzinger, S.P., Mayorga, E., Bouwman, A.F., Kroeze, C., Beusen, A.H.W., Billen, G., cht,
v., G, Dumont, E.L., Fekete, B.M., Garnier, J. & Harrison, J. 2010, "Global River Nutrient
Export: A Scenario Analysis of Past and Future Trends", Global Biogeochemical Cycles, vol.
24, pp. GB0A08-GB0A08.

Corporate Accounting
13
Shim, J.K., Siegel, J.G. and Shim, A.I., 2011. Budgeting basics and beyond (Vol. 574). John
Wiley & Sons.
Tsanakas, A. & Millossovich, P. 2016, "Sensitivity Analysis Using Risk Measures", Risk
Analysis, vol. 36, no. 1, pp. 30-48.
Wright, M.M., Daugaard, D.E., Satrio, J.A. and Brown, R.C., 2010. Techno-economic
analysis of biomass fast pyrolysis to transportation fuels. Fuel, 89, pp.S2-S10.