FUNDAMENTALS OF FINANCE

Fundamentals of Finance



Fundamentals of Finance

Introduction

Capital Budgeting is a process in which a company or an institution evaluates its investment decision, whether is it financially feasible to go for the project or not. It includes various methods and tools to find out whether the investment is feasible or not. These tools have several advantages and disadvantages. These tools include NPV, IRR and Payback Period. We will discuss each one of them individually.

Importance of Capital Budgeting

Expression used in the context of the administration, organization of the Company, business and management. The Budget of Capital is considered synonymous with investments in the long term. Investments that are discussed in the Capital Budget may include fixed assets, intangible assets or equity investments in the Capital Assets. Overall, the Budget for Capital refers to the fact that the money you have to invest (capital) is low, and be budgeted among Alternative Investment competitive. The Budget for Capital includes three basic areas of study:

1. The sizing Optimum of the Company (the area of economics).

2. Determine where to invest: it will determine how much of the resources is capital work and what will constitute non-current assets.

3. Identifying sources of funding: search for cheaper sources of financing, and investing in more profitable projects.

An error in the preparation of forecast asset requirements can have serious consequences, if the firm invests too much in assets, which will incur very strong risks (Graham, et.al, 2001). However, it spends a sufficient amount in fixed assets could have two problems, first your computer may not be efficient enough to enable it to produce in a competitive manner. Second, if you have inadequate capacity, you may lose a portion of its market share in favor of rivals and recapture lost customers requires heavy spending and sales price reductions, which is always expensive.

Capital Budgeting Techniques

Net Present Value

Definition

NPV is a capital budgeting technique based on the techniques of discounted cash flow (DCF). It is a method for evaluating proposals for capital investment by obtaining the PV of net cash flows in the future, discounted at the cost of Capital of the company or the required rate of return (Brounen, 2004, Pp 71-101).

Description

The techniques of discounted cash flow (DCF) are methods to evaluate investment proposals that employ concepts of the value of money over time, two of these are the NPV method and the method of internal rate of return. For the implementation of this approach comes from the following (Chase, 2003, pp. 1753-1763):

Determine the PV and each cash flow, including many inflows as output, minus the capital cost of the project.

Add up discounted cash flows determined in the previous step, this amount should be defined as the projected NPV.

If Net present value is positive, project should be executed, while if in case of negative NPV, it should be rejected.

If the 2 projects are equally mutually exclusive, one with the highest NPV should be selected, provided that the NPV is ...