Reflection On Capital Budgeting FM 8.23.19

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PANES, MARY ROSE R.

Financial Management GMB 722


Friday – 6pm-9pm

TOPIC: CAPITAL BUDGETING


INTRODUCTION:
For this topic, I would like to discuss what Capital Budgeting is and the Tools,
Techniques and Decision Rules of capital budgeting:

1. Payback Period
2. Discounted Payback Period
3. Net Present Value
4. Internal Rate of Return
5. Profitability Index

DISCUSSIONS:
Capital Budgeting is defined as the whole process of analyzing projects and
deciding which ones to include in capital budget. Capital budgeting also known as
investment appraisal.
Capital Budgeting also is the decision process that managers use to identify
those projects that add to the firm’s value and as such it is perhaps the most important
task forced by financial managers and their staff. This decision process has three
important decisions that we should know. First, a firm capital budgeting decisions define
its strategic direction; because it moves into a new product, services or markets must be
preceded by capital expenditure. Second, the results of capital budgeting decisions
continue for many years, reducing flexibility. And lastly, poor budgeting can have
serious financial consequence.
I learned that capital budgeting has seven (7) types investment decision these
are:

1. Replacement this is the maintenance of the business that worn-out or


damaged equipment is necessary if the firm is continue in business.
2. Cost reduction that lowers the cost of labor, materials and other inputs
such as electricity by replacing serviceable but less efficient equipment.
3. Expansion of existing products or markets these expenditures have an
increase of the output of existing products in the market, etc.
4. Expansion into a new products or markets these project involved strategic
decisions that could change the fundamental nature of business, and it
normally require the expenditure of large sums with delayed paybacks.
5. Safety and/or environmental projects these expenditures necessary to
comply with government orders, labor agreements, or insurance policy
terms are called mandatory investment it often involve non-revenue for
producing projects.
6. Research and development these are the expected cash flows form R&D
are often too uncertain to warrant a standard discounted cash flow
analysis.
7. Long term contract, the company often the long term contract to make
long-term contractual arrangement to provide products and services to
specific event.

With capital budgeting, I learned that there are several capital budgeting tools
(CBT) that a Financial Manager can make use of and these are as follow:

 Payback period, in this CBT it accept profit with short term payback. It
simply means the period of time money will be recovered after it has been
invested. This is the easiest and simplest method in Capital Budgeting.
And ignores money after the period. Advantages of it these are easy to
calculate, easy to explain and indicator of project equity. On the other
hand there are some disadvantages also and these are measures
payback and not the profitability, does not consider time value of money
and does not consider risk of the project.
 Discounted payback, in this CBT it also accept short term in term of
discounted payback. In this tool we can use the time value of money.
 Net Present Value (NPV), it accept the profit if the NPV is positive (+) and
it also have an advantages that direct measure of expected increase in
value of firm and this is best method to use because the time value of
money is also involved here. Despite of the advantage it has
disadvantages include complication of how to use and that in terms of
investment, management decision is a major consideration.
 Internal Rate of Return (IRR), if the IRR > cost of capital it should require
rate of return. Advantages of these are shows the return on each money
invested and we can tell how much the the IRR of the actual return could
fall. And the disadvantage is time consuming.
 Profitability Index (P.I), we need to accept if P.I > 1 and do not accept if it
is < 0.

In this CBT the rule of this is when we choose one we need to forget others. And
the manager should cite the percentage and not the amount.

CONCLUSIONS:
Therefore, I conclude that it is important to analyze well the budget before to be
invested in a certain projects. In this topic I will choose or recommend either NPV or
IRR because it is more realistic compare to others.

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