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Capital Budgeting What Process Do

The NPV method is when the company will discount all possible income received from an investment, to where it is in line with their projected minimum rate of return (hurdle rate). At which point, managers will be able to see if the present value will have a positive or negative return for the organization in the future. Those projects that can provide positive present values will more than likely accepted, because they are providing a return that is in line with the companys minimum expectations. As a result, managers can use this method as another way of determining, if a project can meet their minimum objectives. When evaluating different projects, this provides an effective way of comparing the investment with the minimum returns. At which point, managers can see which project would provide the greatest economic benefit to an organization. (“Techniques of Capital Budgeting,” 2009)

The MIRR is when the managers are setting the hurdle rate to be in line with the companys expectations, for the life of the project. This allows managers to conservatively see what will be the minimum projected return to the company, by taking out other factors that could cause the percentage return to become more volatile (such as economic factors). The extra cash flow that is received above the hurdle rate can be reinvested in other projects, at the minimum rate of return. What all of this shows, is that a company can use this method as a way of conservatively accounting for the projected minimum total return. At the same time, this allows management to invest the excess returns in other capital projects, using the same methodology.

Over the course of time, this will help an organization to effectively utilize its free cash flow to meet minimum objectives, while simultaneously investing in other capital spending projects. (“Capital Budgeting Techniques,” n.d.)

Like what was stated previously, the IRR is when you are comparing the return of investing in a capital spending project, with that of more safe investments (such as Treasuries). This is significant, because it can provide a basic foundation as to what would be a logical minimum expected return that the company would see from a project.

Clearly, all three methods would be appropriate for the company. This is because they provide numerous ways of evaluating the risks vs. rewards of an investment. Where, each method will allow managers to see the possible impact that the capital investment will have on the company. When you have numerous methods to corroborate the impact that an investment will have, means that the odds increase that the minimum returns will be achieved. This is the key to successfully identifying good investment opportunities, as the different methodologies will provide a unique way of analyzing the investment.

Bibliography

Capital Budgeting Techniques. (n.d.). Retrieved July 13, 2010 from Murray State website: http://campus.murraystate.edu/academic/faculty/larry.guin/FIN330/CapBudTechniques.htm

Techniques of Capital Budgeting. (2009). Retrieved July 13, 2010 from Maps of World website: http://finance.mapsofworld.com/corporate-finance/capital-budgeting/techniques.html

Cooper, W. (2001). Capital Budgeting Models. Retrieved July 13, 2010 from Entrepreneur website: http://www.entrepreneur.com/tradejournals/article/116186585.html.

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