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Portfolio Project: Capital Budgeting Techniques - Assignment Example
Author : erichowell
Finance & Accounting
Pages 5 (1255 words)
Capital Budgeting Techniques Customer Name University Name Capital Budgeting Techniques There are different techniques to make capital budgeting decisions in order to decide whether an investment is worthwhile or not. Some of the capital budgeting techniques like payback rule, internal rate of return, NPV, and the profitability index…
An investment of, let’s say, $100 if yields $50 every year then it’s payback period will be 2 years because the investment is recovered by the investor after 2 years. This is a very simple method to evaluate an investment but it does not take many complicated factors that play a role in capital budgeting decisions. A disadvantage of this technique is that it is not possible to understand the impact of interest rate changes and inflation in the economy. This method also assumes that exact cash flows coming in future are known. Also it is only a short term measure because some investment gives returns for a longer period of time (Woodruff, 2007). Payback rule is also not a good measure of capital budgeting when initial capital is being borrowed on interest. Internal rate of return is another method to evaluate capital budgeting decisions. Investors can calculated IRR of their investment and determine whether they should take the project or not. Internal rate of return is the rate at which any new project’s net present value becomes zero. It is usually used in situations where the firm is trying to borrow money in order to finance the whole project. An investment should only be considered if its internal rate of return is better than the borrowing cost. ...