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Finance & Accounting
Pages 5 (1255 words)
Name Course Instructor Date Johnson Controls The process of analyzing and selecting various proposals for capital investments is called capital budgeting. Capital budgeting models are one of several techniques used to measure the value of investing in long-term capital investment projects.
Information systems are also considered long-term capital investment projects. The following are some of the traditional capital budgeting models used to evaluate capital projects: The payback method The accounting rate of return on investment (ROI) The net present value The cost-benefit ratio The profitability index The internal rate of return (IRR) These methods rely on measures of cash flows into and out of the firm. Capital projects generate cash flows into and out of the firm. The investment cost is an immediate cash outflow caused by the purchase of the capital equipment (capital outlay). In subsequent periods, the investment may cause additional cash outflows related to repair and maintenance that will be balanced by cash inflows resulting from the investment. Cash inflows take the form of increased revenues generated from the improved facilities or reduced costs in production and operations. The difference between cash outflows and cash inflows (net cash flows) is used for calculating the financial worth of an investment. Once the cash flows have been established, several alternative methods are available for comparing different projects and deciding about the investment. ...
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