As we have discussed earlier, capital budgeting is the process of identifying, evaluating and deciding which of the new projects should be undertaken by the firm. This is one of the most important functions a financial manager needs to perform. The reason for this is that capital budgeting normally deals with making decisions regarding long-term projects. As a result, undertaking these types of projects mean that the funds of the firm will be tied up for a considerable amount of time.
It is key to point extinct that capital budgeting is an extremely difficult task because it involves the forecast of property flows (e.g. sales) generated by the project, cost reduction (e.g. due to a more efficient equipment), etc. However, it is beyond the scope of this course to discuss some of these issues. As we have discussed earlier, this course will entirely look at some of the techniques for evaluating the projects and identifying the appropriate cash flows (from the projects) that atomic consequence 18 needed for the evaluation.
1.
The four decision rules of capital budgeting
It is important to note that the ultimate goal of undertaking a new project is to increase the value of the firm (in the long run), and this will be the driving force for many of the decision rules used to evaluate the projects. There are 4 decision rules a firm can use to help make its decision: (a) payback period, (b) net present value (NPV), (c) profitability index (PI), and (d) intrinsic rate of return (IRR).
(a) Payback Period
The payback period measures the number of years it takes to recover the initial outlay (or investment). It is important to make out that this technique ignores the time value of money and the cash flows from the...If you inadequacy to get a full essay, order it on our website: Orderessay
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