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PLEASE HELP WITH A RESPONSE TO THE POST BELOW. Thank you :)

  1. How do we traditionally define capital budgeting infinance?
  • Capital budgeting is a technique used in Finance by companiesto evaluate and rank the investment projects. These are the largeexpenditure projects including the purchase of plant and equipment,investment in new business, construction of buildings etc.
  1. What is the purpose of capital budgeting in the business firm,and how is it used?
  • Capital budgeting calculation involves cash flows withconversion into time value of money and arriving at a profit. Thereare several methods used for evaluating capital budgeting projects.Payback period method, Net present value method, internal rate ofreturn method and profitability index. All of these methods help amanager to analyze and select the projects based on profitabilityand returns. It is used to help the managers in arriving atinvestment decisions compared with the cost of capital. They alsogive the knowledge of time period within which cash outflows willbe returned. Large businesses rely on NPV and IRR to takeinvestment decisions. This technique provides a real return valuefor a business rather than just calculating the profits.Traditional accounting involves making decisions based on profitswithout considering the time value of money. Capital budgetingtechnique helps the manager to take decisions with present valuesof future returns.

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Jean Keeling
Jean KeelingLv2
28 Sep 2019
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Capital budgeting involves choosing projects that add value to the firm. The net present value (NPV), internal rate of return (IRR) and payback period methods are the most common approaches to project selection. At its core, capital budgeting is measuring an accounting of costs versus benefits. In a way, all business decisions are a series of capital budgeting decisions. Get it wrong, and you can destroy a company.

The capital budgeting tools help financial managers decide on the desirability of the projects. In the real world, however, managers sometimes will make decisions that don't necessarily agree with the decision rules of the payback period, NPV or IRR methods.

For example, consider the two mutually exclusive projects below.

Investments

Cost

Cash Flow 1

Cash Flow 2

Project A

$ 50

$ -

$ 100

Project B

$ 50

$ 50

$ 25

According to the payback period, project B should be selected. Although both projects cost the same, project B has a payback period of one period, while project A will payback in roughly 1.5 periods.

Assuming the discount rate of 5%, NPV(A) = $41 and NPV(B) = $20.

This example illustrates the limitations of the payback period method. Even though the payback period method points to project B, the NPV method points to project A since it has more than twice the NPV value to that of project B. Yet the manager may choose project A. Why?

It may be that the project stakeholder is requesting a quicker return in cash.

For this discussion, create an example problem where two (or more) methods contradict each other. What would be the "appropriate" choice (which project would you choose)? In what cases would you not choose the "best" choice?

PLEASE HELP WITH A RESPONSE TO THE POST BELOW. Thank you

1. How do we traditionally define capital budgeting in finance?Capital budgeting is the arranging procedure that is utilized todecide whether the long-haul venture choice of the association likesubstitution hardware, new apparatus, new items, and so forth meritfinancing money by means of association's capitalization structure.In fund, capital budgeting is done a few techniques like Newpresent esteem, Internal rate of return, Profitability record,Payback period, and so on. Supervisors receive one of the fewstrategies accessible for capital budgeting, yet the independentventures depend on easiest procedures like compensation period.Customarily, capital budgeting was utilized in basic leadershipprocess for interest in long haul resources of the organizations.It is a critical strategy on the grounds that any terrible venturechoice can fundamentally affect the budgetary strength of theassociation. Added to this, the timings of the choice areadditionally critical and numerous capital budgeting choices take along time to be actualized (Kenton, 2018) 2. What is the purpose ofcapital budgeting in a business firm, and how is it used? Theprinciple goal or reason for capital budgeting isn't just tocontrol assets and give perceivability; rather it likewise helps inpositioning ventures and raising assets. The achievement ordisappointment of any business relies upon the powerful use ofaccessible assets and capital budgeting is the arranging procedurethat helps in choices that are presented to hazard andvulnerabilities. It gives huge degree to budgetary chief to assessdistinctive proposition by means of which just the suitable ventureis selected speculation. Along these lines this budgeting strategyis utilized as the technique for successful control on expense ofcapital use undertakings and helps the administration inmaintaining a strategic distance from over speculation and underventure (Kenton, 2018)

Required:
Compare the results of the three (3) methods by quality of information for decision making. Using what you have learned about the three (3) methods, identify the best project by the criteria of long term increase in value. Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods.

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

Investment Sales Price CF1 CF2
Gas Station A $50,000 $0 $100,000
Gas Station B $50,000 $50,000 $25,000



Three (3) Capital Budgeting Methods are presented:

Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.

Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115

Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.

Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.

The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest

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