The Importance Of Capital Budgeting Essay

2681 words - 11 pages

The decision of whether to accept or deny an investment project as part of a company's growth initiatives, involves determining the investment rate of return that such a project will generate. Capital budgeting is a step by step process that businesses use to determine the merits of an investment project. Whenever making an investment decision whether big or small it is imperative that we take into account the numerous risks and costs involved in it. Without conducting sufficient research on this it is highly dangerous, not to mention potentially lethal for the organization it self to go right ahead and bluntly invest without taking the customary precautions. For any investment that is about to take place business managers have a variety of methods to employ to assess the type, and quantity of risks and benefits involved in adopting that particular decision. It is highly recommended that any business manager no matter how experienced and learned actively employ these techniques and methods to save his business from potentially going bankrupt or ending up getting mired in any other disaster of the like. “The idea of capital budgeting is to assist managers of organizations make profitable and therefore informed decisions on acquiring and disposing of assets. It is only common sense that any normal person cannot know when and how to purchase any sort of asset, for your factory; or a new vehicle to deliver your goods; or even new land on which to build an extension to your showrooms? Capital budgeting has many angles to it because of which it can be employed and each technique will tell us how a project is affordable in numerical terms only, but because of which it will be easier for managers to base their decision on the information that is extracted from these numerical techniques. As it is already understood that capital budgeting is concerned with acquiring and disposing of assets, we will not be giving examples relating to disposals in this report. The techniques can easily be applied to such situations; but because the situation is such that it calls for investment of assets, and the kind of precautionary measures that are relevant to following up on these decisions, we shall strictly talk in terms of investments. The key numerical techniques to be that are of assistance when engaging in investment decisions are:

The Net Present Value Technique (NPV)

The Internal Rate of Return Technique (IRR) The Payback Period Technique (PB) The Accounting Rate of Return Technique (ARR)”: Net Present Value This technique is concerned simply with time value of money. The idea behind the NPV technique is that it DISCOUNTS the cash flows generated by an asset back to the present day: thus the NPV technique is concerned with the time value of money. The result we are faced with is usually in the form: Year Cash Flows(£) Discount Factors (15%) Present Values(£) 0...

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