FM Unit VIII Paper: Capital Budgeting Techniques

Capital Budgeting Techniques
Name:
Institution:
Date:
CAPITAL BUDGETING TECHNIQUES
Capital budgeting is the process of planning which is used to determine the investments that are worth pursuing within an organization. Capital budgeting is also known as investment appraisal employs a procedure that conclude whether long term investments of a certain organization, expenditure or major capital are worth to pursue (Lasher, 2011). Various techniques are applicable in capital budgeting even though each of them contains comparable strengths and weaknesses to the other, according to their operations.
Various formal methods are usable in capital budgeting and the techniques suitable for this function include the Net profit value, the profitability index, international rate return, as well as payback period. The long-term investment assessed by these techniques may include replacement machinery, new machinery, new products, new plants, and projects of research development. The Net present value abbreviated as NPV, is usable in estimating the value of potential project through valuation of discounted cash flow. This kind of valuation needs estimating the timing and size of the entire incremental cash flows derived in the project. The Net present value is usually affected greatly by the rate of discount and thus it is important to select the proper rate occasionally called the hurdle rate. This technique however depends on estimates that may not be so accurate (Lasher, 2011).
On the other hand, International rate of return abbreviated as IRR, is the rate of discount that offers a zero to the net present value. This is regularly fit for measuring the efficiency of investment. The IRR technique result in the similar decision as the NPV techniques for non-mutuality restricted projects wit...