When making capital decisions to invest funds, companies use different techniques for such capital expenditure projects. The best decision has to consider the attractiveness of the investment and the time value of money. Other factors to consider are; future cash flow from the investment as well as other risks and uncertainties expected to the cash flow. Performance metrics are the other Factor to consider before funding a capital expenditure Project (Woodruff, 2). The most common methods are the payback period, the internal rates of return evaluation, and the net present value. The other methods include the Accounting Rate of Return. No one method is truly the “best,” without the qualifications. None of these methods is completely reliable by themselves. Each of these methods has its flaws.
situations where you might use an alternative method
There are various situations where business may use alternative methods and leave the other one. For example, when choosing net price value, it would be used as an alternative to IRR when a business project has now a normal cash flow (Renaud, 1). This is because the net price value method can lead to a decision related to the accept-or-reject situation. This means that nip is a better method that can be used to evaluate a project that is manually exclusive as compared to the IRR method.
Reasons for using multiple budgeting techniques
In all the capital budgeting techniques, each one of them has an advantage over the other. Various approaches can be used to determine the best capital budgeting technique. There are times when managers or executive officers decide to use multiple methods while performing percentages for figures. In such a situation, executives prefer IRR or internal rate of return instead of using the net present value (John, 1). This means that they are using two techniques of IRR and the rate of return sims they would like to express the performance in terms of percentages and dollar figures. The other reason is inflation ht have to be taken into consideration making it necessary to be flexible. The IRR will be used to simplify the project to a single number to know the management to determine if it is viable from an economic perspective. In this case, the company will do the calculation of the required return rate to show the net gain over sometime. To avoid the fall in the rate of return for a loss through a period of time, the company NPV to determine whether it is likely to fail or not in the future are the reasons for the failure. This is because it can give the present value of cash outflows that projects a certain period of time.
examples that would help the decision
If I am involved in the capital budgeting procedures in my current position, I know that capital budgeting for a small scale will involve the basic steps of the cost of investment. Projecting the Investment in terms of cash flow before comparing it with the projected earnings taking into consideration the rates of inflation and the time value for this investment (Batra, and Satish, 29). For example, buying equipment would cost 20000 dollars. If it generates 5000 dollars as an annual return, it would appear to be a Payback on the given investment over a period of 3 years. However, there is an inflation of 30% that takes place on an annual basis, the Investment return at the end of the first tab 20000 whose work is 15308 dollars taking into consideration the inflation (20,000 /1.3=15,385). This type of investment will only generate $325 which is the real value after the end of the year.
Woodruff, Jim. “Three Primary Methods Used to Make Capital Budgeting Decisions.” Small Business – Chron.com, Chron.com, 6 Mar. 2019, smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting-decisions-11570.html.
Renaud, Rob. “Capital Budgeting: IRR or NPV?” Investopedia, Investopedia, 12 Mar. 2019, www.investopedia.com/ask/answers/05/irrvsnpvcapitalbudgeting.asp.
John blue. “Capital Budgeting Techniques, Importance, and Example.” EduPristine, 11 Oct. 2018, www.edupristine.com/blog/capital-budgeting-techniques.
Batra, Roopali, and Satish Verma. “Capital budgeting practices in Indian companies.” IIMB Management Review29.1 (2017): 29-44.