Report Example on Capital Budgeting Techniques

Introduction

Present Net Value seeks to evaluate the profitability of projects by discounting cash outflows and inflows of an investment project by a specific rate of return. (Present value of cash inflows -cash outflows=NPV). The NPV method utilizes the aspect of the time value of money is important in taxation and investment projects, aiming to maximize shareholder's earnings. To determine the viability of a project, the NPV must meet certain conditions. A positive NPV indicates that the project is profitable because cash flows will lead to an excess cost capital. A negative NPV indicates that the inflows of an investment will result in a return less than capital.

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Appraisal Method

The payback period statistic is an investment appraisal method that indicates the time needed to recover the money invested in a project from the cash flows. The payback period is calculated by dividing the total amount invested by annual cashflows (Gupta,2017). The acceptance benchmark of the payback period is the time allowed to recover the capital equal or less the actual payback period. If the payback period is more than the maximum allowed time, the project is not desirable. The statistic is crucial in ensuring the liquidity of companies and analyzing risk.

Internal Rate

The Internal rate of return is a discounted budgeting technique that equates cash outflows and inflows of a project. The IRR is used by many companies to evaluate the performance of investment projects (Patrick &French,2016).The IRR analysis in evaluating stock valuations and in infrastructure equity markets. The acceptance benchmark of the IRR technique is whether the IRR is equal to the discount rate or higher. If the IRR is higher than the discount rate, the project is desirable.

Conclusion

MIRR is the investment return by considering both the cash flows and the IRR of these cash flows based on a specific reinvestment rate. MIRR has played a crucial role in comparison to different investments. The major drawback of MIRR is the assumption of reinvestment and multiple IRRs. The modified internal rate of return is a better technique for evaluating the desirability and profitability of a project.

References

Gupta, D. (2017). Capital budgeting decisions and the firm’s size. International Journal of Economic Behavior and Organization, 4(6), 45. 10.11648/j.ijebo.20160406.11

Patrick, M., & French, N. (2016). The internal rate of return (IRR): projections, benchmarks and pitfalls. Journal of Property Investment & Finance.
https://www.emerald.com/insight/content/doi/10.1108/JPIF-07-2016-0059/full/html?mobileUi=0&fullSc=1.