Capital budgeting evaluation techniques

Capital budgeting evaluation techniques

Introduction

In any business, investment decision is based on sacrifice on other opportunities available to firm. Therefore, capital budgeting process could be long and complex for many businesses. The decision for capital budgeting can be categorized into two different phases. First phase refers to the identification of potential investment options by firm's management. Later phase is related to evaluation of those options by various techniques and identification of best possible option (Besley & Brigham, 2007).

Discussion

In current environment, where competition is at its peak a firm seeking for similar opportunities finds it difficult to attain. However, capital financing projects can be categorized into three broader categories. First a capital project can be related to revenue enhancement. Secondly a capital project is categorized in cost reducing investments. Lastly, a capital project is considered when there is mandate by government or other bodies. Various methods to evaluate capital budgeting are further discussed in latter discussion (Besley & Brigham, 2007).

Payback period

Payback period refers to capital budgeting concept in which period is calculated that recover the original investment of the project. There are few advantages of payback period and certain disadvantages too. Advantage is of payback period are; it is easy to use and one can apply payback period with minimal financial knowledge, and it give a business a time frame in which its project will be recovering its original investment. Disadvantage of payback period includes as payback period cannot provide the clear picture as it does not includes the factor of time value of money. Also, payback period is concerned with the recovery of initial investment of the project and does not account the future returns (Besley & Brigham, 2007).

Discounted payback period

Discounted payback period is similar to payback period except it takes present value of cash flows rather ...