MAKING CAPITAL INVESTMENT DECISIONS

Making Capital Investment Decisions



Making Capital Investment Decisions

Introduction

Capital Budgeting techniques are used by investors and managers when they are proposing a feasibility of the project which is in the pipeline or planning process. There are several techniques for appraising a capital investment. It depends on the risk taking ability of the manager or an investor that which technique they will use for appraising a project and how that technique will help in achieving the desired objectives or calculation of feasibility. Some techniques in the capital budgeting and investment appraisal are primarily based on the risk appetite of the investor. A risk averse investor will opt for pay back while a risk taker will opt for NPV (Atrill & McLaney, 2009).

IRR or internal rate of return is the capital budgeting and appraisal technique which is used to calculate the growth opportunity which a business yields in its future operations. The project which has a higher internal rate of return is the project which has the potential to yield more profits or returns in the future operations. IRR is a technique for managers to make a decision regarding the best investment. However there are several other techniques which can also be utilized in order to compute the profitability of the investment and returns which an investment might yield in future. The following are the list of techniques which will discussed in the paper and how they affect the investment appraisal and budgeting decision and what factors do they while providing a future estimate for an investment (Graham & Harvey, 2001, pp.187-243).

Net Present Value (NPV)

Payback

Discounted Payback

Accounting rate of Return

Modified Internal Rate of Return (MIRR)

NPV

Net Present value is the estimate of the present values of the future cash flows which a project will yield in future. The NPV estimates incorporate the time value of function and also accounts for negative cash flows if there are any in the future cash flows which a business might generate over the period of time. The NPV are utilized in calculating the feasibility of the projects by using the appropriate discount rate which is used for the project. The discount may include the risk, opportunity cost of the investment and inflation. Thus it actually provides a very reasonable estimate for the future business prospects (Osborne, 2010, pp.234-239).

Case Calculation

Project 1

Present value of the future cash flows = 1000/0.2 = 5000

Initial Investment - Present ...