Capital Budgeting Assignment Help
Capital budgeting is a process of checking, analyzing, and ranking the assets to be purchased according to which asset will provide the company with the most return. There are methods of finding which asset is going to be ranked above the other and why. There are three methods for it:
- Internal RoR
- Payback Period
There are more ways to decide which asset should be purchased. They will be mentioned in our assignment help in detail.
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As mentioned above, capital budgeting is the process of choosing the right asset for the company. The company works to increase the amount of profit it earns. This requires the company to buy new assets in every five years. These assets may be: a machine that would produce products, a piece of land that would be used to build a storehouse or a factory or any such asset that the company plans to use to increase its productivity or its profit.
Choosing the right asset is a big decision, as it depletes a big amount from the monetary resource of the company. Further, these assets are analyzed to see which would bring the most monetary benefit to the company and which would last the longest before it becomes a liability. The purchase price and the depreciation are subtracted from the total cash flow the asset would generate in its lifetime.
There are three most used methods to analyze:
- Payback Period- These are the number of years in which the company expects to recover the amount it has invested. This the basic and most used method.
When a company invests in some capital asset, it invests for the purpose of earning profit. But this profit would be earned, once the amount invested in it is recovered.
For example- If a company invests in a machine which costs 90,000 and the cash flow from it is 30,000 per year, it would take three years for the company to recover its investment. And if the investment is for 1,10,000, then it would take between three to four years for the company to recover the amount invested.
Once, the company has recovered the amount invested, whatever other cash flow the machine generates is considered as profit.
This method further has two parts.
One: Where it is assumed that the cash flow from the machine will be the same every year. This method is quick but may not be accurate. During the four years they may be many changes that may either increase or decrease the profit earned.
The Second: This method is where every year the cost is reduced according to the cash flow of that year. This method is slower but would be more accurate. In this method the company will know if the investment will be recovered before or after the estimated day.
- Rate of Return- This method is another common method to analyze the investment. This method is known and used in a few different ways.
1. Accounting RoR
2. Internal RoR
3. Average RoR
Even though it is used in different ways, but the method is still similar to the original. This method analyses the price of the investment and the profit after tax it will deliver. The investment cost is divided by the profit it will generate in its lifetime. If the actual return is more than the expected return, then the investment is considered to be a good investment. If the actual investment is less than the expected investment, then it is considered as a bad investment, and the company would search for another investment.
There are a few limitations to it.
1. It doesn’t consider years, it is used for.
2. It spreads the profit equally over all the year instead of how it is actually generated.
- Present Value method- This method is also called Required Earning Ratio.
It has Four Branches
- NPV Method
- Terminal Value Method
- IRoR Method
- PI Method
In this method, cash flow for the current year is calculated. This cash flow may be negative or positive. Then the cash flow is subtracted from the initial investment and if it exceeds the estimated amount it is considered to be a good investment.
Terminal Value Method- In this method it is assumed that every year the amount that is earned is reinvested in another investment.
Then the end amount after all the years of compounding is compared to the amount initially invested in the project. If the amount received with the compounded interest is more than the initial investment, this method will be supported.
Profitability Index Method- This method compares the ratio of the present value of the future cash flow to create the current ratio. It tries to find the present profit for the amount invested. So, the higher the ranking of the investment the higher the chance of it being selected as the investment.
There are more topics covered in our assignment help. This is just a short description of what capital budgeting is. The assignment will carry more in-depth information about all the mentioned topics above and other important subjects.
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