Definition of the main capital budgeting techniques
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Definition of the main capital budgeting techniques
NPV
The net present value discounts all the cash flows after-tax by the weighted average cost of capital for the managers to decide whether it is profitable to undertake a project or not. That helps to reveal the exact profit generated from a project in comparison with all other alternatives. A project with a positive net present value is accepted and rejected if the "net present value" is negative.
IRR
The internal rate of return is a method that uses a discount rate to make the present value of all cash flows that the company will receive at a future date be equal to zero. Many investors will prefer a project whose rate of return is the highest. A project is profitable if the internal rate of return is more than the weighted average cost of capital (Higgins, Koski & Mitton 2016).
Payback period
The payback period calculates the length of time taken by a company to get cash flows that are enough to recover the money used in the original investment. For example, a capital budgeting project may require $500,000 as of the initial cash outlay. The payback period is the number of years investors will need for the cash inflows to generate a $ 500,000 outflow.
Name at least two capital budgeting techniques (e.g., NPV, IRR, Payback Period, etc.) that you used to arrive at investment decisions
The two capital budgeting techniques that I used to arrive at investment decisions are NPV and IRR. Net present value can measure added profitability directly and compares projects that are mutually exclusive simultaneously. Managers can understand all the relevant factors to consider in intelligent decision-making.
The internal rate of return allows proper assessment of every project about the capital structure of the company. The company compares the projects based on the returns generated from the amount of capital invested. That provides a significant valuation measure for analyzing capital budgeting of individual projects.