Capital budgeting techniques are used to check whether a company can invest in a specific project or not. Before undertaking any capital investment, it is imperative to consider the investment's value and future cash flows from the intended project and any uncertainties that could arise from the investment (Woodruff, 2019). Net Present Value (NPV) and Payback Period are two approaches used in capital budgeting. The payback period approach is the most commonly used method as it is easy to calculate. More specifically, the technique denotes the period under which the investor would recover the original investment (Woodruff, 2019). For instance, if one invests $20000 to buy a machine and its projected profit per year is $5000, then the payback period is four years. However, this approach does not account for the time value of money. In NPV, the investor's return rate is used to calculate the present value of future cash flows (Roseke, 2019). The project is only given the green light if the results surpass the initial investments. As long as the project generates cash flow, then the time value of money is not considered. Moreover, it considered the timing of future cash flows, where the preference of receiving back the initial investment early on is better than in later years.
Hello Loscena Green-Davis, I appreciate your work on capital budgeting and its techniques. How you articulated your points shows your understanding of the discussion question. Indeed, capital budgeting is a useful tool organization use to analyze the viability of their investment projects. I agree that decision-making during project investment requires more than one technique to satisfy all the requirements and projections. I researched the Internal Rate of Return and discovered that it uses the same formula as the NVP, but it equates the net present value to zero (Sarwary, 2020). Further research also revealed that the Internal Rate of Return represents the annual growth a project is expected to generate.
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References
Roseke, B. (2019). The 3 main capital budgeting methods . ProjectEngineer. https://www.projectengineer.net/the-3-main-capital-budgeting-methods/
Sarwary, Z. (2020). Strategy and capital budgeting techniques: The moderating role of entrepreneurial structure. International Journal of Managerial and Financial Accounting , 12 (1), 48. https://doi.org/10.1504/ijmfa.2020.107001
Woodruff, J. (2019). Three primary methods used to make capital budgeting decisions . Small Business - Chron.com. https://smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting-decisions-11570.html
