CAPITAL BUDGETING TECHNIQUES

Capital Budgeting and Investment Appraisal: The Epsilon PLC Case

Abstract

Capital budgeting techniques helps organizations undertaking long-term or capital expenditures decisions through calculating the potential value that is generated by the company through implementing such decision. The report covers an application of the capital budgeting technique with context to the decision that Epsilon PLC is considering for an acquisition of capital i.e. machinery.

Introduction1

Discussion2

Net Present Value2

Explanation & Importance2

Decision Criteria for NPV3

Epsilon PLC Project's NPV3

Interpretation of the Epsilon's Project NPV4

Internal Rate of Return4

Explanation and Importance4

Decision Criteria for IRR4

Epsilon PLC Project's IRR5

Interpretation of the Epsilon's Project IRR5

Payback Period5

Explanation and Importance5

Decision Criteria of Payback Period6

Epsilon PLC Project's Payback Period Calculation6

Interpretation of the Epsilon's Project Payback Period7

Return on Capital Employed (ROCE)7

Explanation and Importance7

Decision Criteria of ROCE7

Epsilon PLC Project's ROCE Calculation8

Interpretation of the Epsilon's ROCE Calculated8

Conclusion or Recommendation8

References9

Capital Budgeting and Investment Appraisal: The Epsilon PLC Case

Introduction

Capital budgeting or investment appraisal techniques aids the companies to take the best decision that will be mostly beneficial for the organization in the near future (Peterson & Fabozzi, 2004, pp. 1-42). Capital expenditures are usually higher than revenue expenditures and therefore, corporations tend to understand either the decision they are going to make will benefit the firm or shall be written off as a loss in the books of accounts. The investment appraisal techniques provides the companies to assess the level of expected returns that will be earned over the period of time such as the life of asset in case of purchase of machinery (Baker & English, 2011, pp. 1-13). It assists the company to estimate the future benefits and the costs over the project's life and aids in calculating the value-driven by implementing a decision, prior to the decision. Long-term forecasting i.e. the estimated benefits that can be driven by the management's decision over the costs for a foreseeable future can be made possible through the appropriate application of the capital budgeting techniques. Because foreseeable future is usually long-term and that is the basic reason that it helps in forecasting for long-term future of the company. Forecasts are forecasts and therefore, are subject to error and inaccuracy. Huge outlays based on the unrealistic forecasts and the wildly optimistic forecasts can danger the business and can even sometimes bring the business at the brink of collapse. The capital acquisition decisions therefore involve a much higher level of business risk and they need to be assessed proactively to avoid any danger to the business that can be caused by such decision. Reliable forecasts, using various scientific models available today, help the companies to forecast their cash flows on which the capital budgeting techniques operate. The clear expression of the assumptions made while forecasting and the rationale behind a forecasted value shall be close to reality as much as possible to predict a plausible figure. The report is written with an aim to undertake the application of the investment appraisal techniques on the decision to be made by the management of the Epsilon PLC regarding a typical capital budgeting ...