Capitalization and Investment



Capitalization and Investment

Q1.

A Budget is a paper that converts strategy into funds. Funds required to complete the planned activites (expenses) and funds that will need to be produced to over come the cost of getting the activities done (profit). Or in other words we can say it is a financial plan for a specific period of time. It is an informed guess that how many funds a company need to start the work (Shapiro, n.d). Invested capital must present the possibility to determine the profit to investor at least equal to the other investment project or other risky project. In order to evaluate the financial performance of the firm, different financial statements are used.

Following are the financial components:

Net present Value

It is the difference between all the present value of inflows and all the present value of outflow associated with a project (Björnsdóttir, 2010). A key element of this process is the “Discount rate” or “Interest rate” which is used to determine the discount future cash flows to their present values (Hansen et.al, n.d). The formula of NPV is:



Internal rate of return (IRR)

IRR is a ratio that depends on the return on invested capital (Björnsdóttir, 2010), or in other words, It is the interest rate that put the investment project's NPV at “0”. It is implement in capital budgeting to compare and measure the profitability of investments.

Payback period

The payback period represent the amount of time required to recover the primary cost of capital budgeting project. Payback period is use as capital budgeting decisions rule specifies that the entire individual project with a payback period less than a required number of years should be accepted.

Payback Period =

Initial Investment

Cash Inflow per Period

Income Statement

This financial statement represents the performance of the project for a specific point of time; it indicates that the project is in profit or loss (Björnsdóttir, 2010). It is a process of adding all revenues and income, and then deduct from all the expenses and cost incurred in that fiscal year.

Cash Flow

The statement of cash flow represents the actual cash flows of a firm or a project. It is composed of all the sources of expenses and income (Björnsdóttir, 2010).

Balance sheet

Balance sheet indicates a company's financial position at the end of the specific period of time. It is a statement of the company's investment and gives priority to the claims to be payoff (Björnsdóttir, 2010).

Q2.

Disadvantages and advantages of NPV

Net present value (NPV) helps in maximizing and increasing the company's value, it gives priority to the time value of money. While evaluating NPV, both before cash flow and after cash flow over the period of the project are regarded. It may not always give the correct response when the projects are of a different nature, but risk and profitability of the projects are given high priority. NPV is difficult to calculate the discount rate.

Advantages and disadvantages of IRR

IRR is a good tool for ...