Capital Budgeting Essay

697 Words3 Pages
Strident Marks can utilize the capital budgeting to evaluate their proposed long-term investments. Once we have identified a list of potential investment projects, the next step in the process will be to estimate the expected cash flows and risk of each project. Based on these estimates, we can evaluate each project and decide which set of projects are the best for Strident Marks to undertake. The primary decision methods used to evaluate the projects will be payback, net present value, and internal rate of return(Gallagher, 2003).

The simplest capital budgeting method is the payback method. The analyst must calculate the number of years it will take to recoup the project's initial investment (Gallagher, 2003). This is done by adding
The equation to calculate NPV is as follows:

where CFt is the cash flow at time t, k is the appropriate discount rate. Our project can be acceptable if the NPV is greater than or equal to zero and unacceptable otherwise. An NPV profile that shows the NPV for various discount rates will show how sensitive the project's NPV is to the discount rate assumption. Taking into account our Project's key financial data, we can compute the NPV as follows:

Net Present Value Project Discount: 10% Time Strident Marks Present Value
0 -10,000.00 -\$10,000
1 \$7,500.00 \$6,818
2 \$7,500.00 \$6,198
3 \$7,500.00 \$5,635 PV_Benefits \$18,651 Net Present Value \$8,651

The problem with the NPV method is that this method will be difficult to explain to the stakeholders who are not financially literate. Another problem that we will face using this method is that NPV is calculated in dollars, instead of percentages (Gallagher, 2003). Many stakeholders prefer to work with percentages to easily compare the project with other alternatives.

The third method we can use to gauge the worth of its upcoming project is by using Internal rate of return (IRR). IRR is the rate of return the project will earn, given its incremental cash flows and initial investment. It is the discount rate that makes the project's NPV = 0. IRR is calculated by setting the NPV to zero and solving for the discount rate (Gallagher, 2003).

By applying the current Project Discount rate