Financial Decisions

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1. When making a capital budgeting decision, I would not apply the payback rule at all. The reason for this is that the role of the manager is to deliver the highest value to the shareholders. In order to do this all of the cash flows from a project must be taken into consideration when making a decision about that project. The payback rule effectively ignores any cash flows that occur after the payback period. The net present value (NPV) calculation, however, takes into account all of the incremental cash flows. That makes the NPV the superior method of making an investment decision. The net present value would be used on the basis of the first rule of thumb: that any project with a positive NPV should be undertaken. There are caveats to that rule, however. If there are two mutually exclusive projects, then the project with the higher NPV should be taken. Projects should also be subject to sensitivity analysis if one project is significantly riskier than another then the investment decision could be affected. Additionally, if the two projects are of significantly different length, then the reinvestment period for the proceeds of the first project should probably be considered as well even if the figures are not explicitly taken into the NPV calculation (they shouldn't be). In any case, the NPV is the superior means by which an investment decision is made based on capital budgeting principles. 2. Debt financing has the benefit to an organization of being the lowest
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