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Business & Marketing
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English (U.S.)
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Topic:
Capital Budgeting techniques
Essay Instructions:
Using the CSU Online Library and the unit reading assignment, explore the capital budgeting techniques covered in the unit, NPV, PI, IRR, and Payback. Compare and contrast each of the techniques with an emphasis on comparative strengths and weaknesses. Be sure to show you understand how each is applied and used in capital budgeting decisions. Use Microsoft Word to complete your answer. Your paper on comparing techniques should be between two to three pages.
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Capital Budgeting techniques
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There are strengths and weaknesses of various capital budgeting techniques and large organizations typically utilize a variety of techniques to make decisions on whether to accept or reject projects. NPV is the most favored technique as it shows the value of a project and adds the value of a project. The IRR measures profitability as percentage of return, while the PI measures profitability in comparison to the investment. On the other hand, the payback period technique shows the risk and liquidity of projects. The different capital budgeting techniques show different information and decision criteria. Even though, the NPV has greatest weight while making decisions, it is important to focus on information in other criteria. This essay compares and contrasts NPV, PI, IRR, and payback focusing on the strengths and weaknesses of these techniques.
The NPV discounts cash flows, and estimates the benefits of an investment as the difference between expected cash inflows over cash out flows. The major benefits of the technique are that it maximizes a firm’s value and takes into account the time value of money unlike the payback period (Bringham & Daves, 2012). Since the calculation takes into account the cash flow before and over the lifespan of an investment project it is more comprehensive than the payback period. The NPV technique prioritizes on the profitability and risk of investments, unlike the payback period techniques. Another weakness of the NPV, is that it is difficult to use the appropriate discount rate and this complicates the risky nature of projects depends on the rates used. Both the IRR and the NPV compare cash flows with cost, but since the NPV is not a ratio this is a major strength of the technique.
Similar to the NPV, the Profitability Index (PI) focuses on discounted cash flows, and the main strength is that it can be utilized when there are resource constraints for an investment project (Bringham & Daves, 2012). Equally, the technique focuses on the time value of money and is better than unadjusted payback period. PI shows the margin of safety, and it is possible for the firm to assess the best decision when one can measure wealth created taking into account of the initial outlay. Even though, there is a need to first calculate the NPV, the technique gives a glimpse of capital rationing of the organization. This is particularly important for smaller firms with low profits or firms which cannot ea...
Name
Course
Instructor
Date
There are strengths and weaknesses of various capital budgeting techniques and large organizations typically utilize a variety of techniques to make decisions on whether to accept or reject projects. NPV is the most favored technique as it shows the value of a project and adds the value of a project. The IRR measures profitability as percentage of return, while the PI measures profitability in comparison to the investment. On the other hand, the payback period technique shows the risk and liquidity of projects. The different capital budgeting techniques show different information and decision criteria. Even though, the NPV has greatest weight while making decisions, it is important to focus on information in other criteria. This essay compares and contrasts NPV, PI, IRR, and payback focusing on the strengths and weaknesses of these techniques.
The NPV discounts cash flows, and estimates the benefits of an investment as the difference between expected cash inflows over cash out flows. The major benefits of the technique are that it maximizes a firm’s value and takes into account the time value of money unlike the payback period (Bringham & Daves, 2012). Since the calculation takes into account the cash flow before and over the lifespan of an investment project it is more comprehensive than the payback period. The NPV technique prioritizes on the profitability and risk of investments, unlike the payback period techniques. Another weakness of the NPV, is that it is difficult to use the appropriate discount rate and this complicates the risky nature of projects depends on the rates used. Both the IRR and the NPV compare cash flows with cost, but since the NPV is not a ratio this is a major strength of the technique.
Similar to the NPV, the Profitability Index (PI) focuses on discounted cash flows, and the main strength is that it can be utilized when there are resource constraints for an investment project (Bringham & Daves, 2012). Equally, the technique focuses on the time value of money and is better than unadjusted payback period. PI shows the margin of safety, and it is possible for the firm to assess the best decision when one can measure wealth created taking into account of the initial outlay. Even though, there is a need to first calculate the NPV, the technique gives a glimpse of capital rationing of the organization. This is particularly important for smaller firms with low profits or firms which cannot ea...
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