Capital Budgeting
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Capital Budgeting
Introduction
Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the firms goal of maximizing owner wealth. A firm using capital budgeting, their goal is to see if there fixed income will cover itself for profit. Fixed incomes are things such as land, plant and equipment. When a firm using a machine to produce its good or service. They most of the time what the machine to
produce the amount that they paid for the machine and more. The capital expenditure is the outlay of fund that a firm expects to produce and benefit with in a one year.
The Capital Budgeting Process
When approaching the problem of trying to the measure capital budgeting. The first step in capital budgeting is the Proposal generation. The proposals are made at all levels within a business organization and are reviewed by finance personal. The Second step in the process in the review and analysis. The formal review and analysis is performed to assess the appropriateness of proposals and evaluate their economic viability. Once the analysis is complete, a summary report is summated to decision makers. The third step in the process will be the Decision making. Firms typically delegate capital expenditure decision making on the basis of dollar limits. The board of directors must authorize expenditures beyond a certain amount. Often plant manager are given authority to make decisions necessary to keep the production line is moving.
The forth step in the capital budgeting process is the Implementation. This process involves expenditures that come from projects implemented. Expenditures for a large project often in these phases. The final step in the process will be the follow-up stage. Results are monitored and tell the actual outcomes.
Sunk cost and Opportunity Cost
Doing the time of estimating the relevant cash flows associated with a proposed capital expenditure, the firm must recognize any sunk cost and opportunity cost. When determining projects incremental cash flows. The suck costs are cash outlays that have already been made and have no effect on the cash flows.
The opportunity costs are cash flows that could be realized from the best alternative use of an owned asset.
Net present Value (NPV)
The NPV gives explicit consideration to the time value of money. The NPV is considered a sophisticated capital budgeting technique. The NPV is measured by subtracting a projects initial investment from the present value of the cash inflows discounted at a rate equal to the form cost of capital. The NPV measures inflows and out flows. When putting your input in to the chart. The chart requires the amount of years that the firms think it will take to retrieve its investment. The input of the out flow is entering in to the charts as a negative. The reason why the number is entered as a negative is because that is the amount of money the firm is giving out to pay for the machine.
INPUT
LIFE OF PROJECT
DISCOUNT RATE/ REQUIRED
RATE OF RETURN (i)
8.000%
CASHFLOWS ($$)
(58,300.00)
19,080.00
15,900.00
26,500.00
10,600.00
8,480.00
Recaptured Depreciation
Recaptured depreciation is the portion of an assets sale price that is above its book value and below its initial purchase price. When a firm uses this method they are simple taking an old machine and selling it for more then the current worth. We will now look at an example of “recaptured depreciation”. A few years ago, Ransack Industries implemented an inventory auditing system at an installed cost of $159,000, has taken depreciation totaling $112,890. If Ransack sold the system for $$99,852, how much recaptured depreciation would result? Recaptured depreciation=Sale price-Book value, Book value=Installed cost of the asset-Accumulated depreciation,
INPUT
Installed Cost
159,000
Depreciation
112,890
Selling Price
99,852
CALCULATIONS
Book Value
46,110
Recaptured Dep.
53,742
Global Capital Budgeting
In the international business world firms also use the Capital budgeting process. When entering in to the international market there a couple of thing that are measured different. The First thing is the cash outflows and inflows that occur in foreign currently Companies face long-term and short-term currency risk related to both the invested capital and the cash flows resulting form it. The Second thing is the foreign investment entail potentially significant political risk. Political risks can be minimized by using both operating and financial strategies.
TECHNOLOGY
When discussing capital budgeting, one must include the effects of technology. Technology assessment can support the capital budgeting process by providing key information for making decisions about capital requests. Technology assessment has been defined as a method for evaluating the effectiveness of equipment, drugs, and clinical procedures.(e) However, in terms of capital equipment planning, technology assessment can be defined more broadly as a method of evaluating current and requested capital equipment by considering the results of published clinical investigations and of physical assessment of the equipment in the decision-making process. Technology assessment provides information for decision making in three areas. The departments equipment needs. Information about a departments needs might include the role or purpose of the department, the type of procedures performed, the volume of activity, hours of operation, productivity problems, and so forth. This information contributes to an understanding of a departments