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 Capital Budgeting


 Basically, capital budgeting is utilized for purposes of maximizing the returns one gets for any investment made. Indeed, for any business, the key goal is to maximize the returns it makes. This is in line with the shareholder wealth maximization principle. If the business fails in its quest to maximize the returns it makes, its long-term viability might end up being compromised especially in a competitive marketplace. In most cases, the two models used for evaluation of capital investments include the IRR model and the NPV model. In this text, I use the two models to evaluate a capital investment where a pizza oven purchase is to be made for a restaurant.


Net Present Value (NPV)

The net present value is used to simply denote how much a dollar to be received in future is really worth currently (Dayananda 2002). By the use of the NPV, we can easily get a way of valuing a given project. In this case, to calculate the NPV of the project, we shall have to have a look at the projected cash inflows as well as outflows. By doing this, we shall be able to decide if purchasing the oven is a sound investment or not.In this case, we have a P1 of 0.34 which is essentially less than one. This is largely because the net present value is negative. In this regard, the project should be rejected because it has a negative NPV.


NB

Please check from the attached spreadsheet


The Internal Rate of Return (IRR)

The internal rate of return as a model utilized in capital budgeting to determine how profitable an undertaking is (Shapiro 2005). Another widely used name for IRR method is the discounted cash flow rate of return. The IRR in this case is -16% and hence it is less that the cost of capital which stands at 9%. In that regard, the purchases of the oven should not be undertaken.


NB

Please check from the attached spreadsheet


References

Dayananda, D. (2002). Capital budgeting: financial appraisal of investment projects. Cambridge University Press

Shapiro, A.C. (2005). Capital budgeting and investment analysis. Pearson/Prentice Hall


 
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