...Phase 3 Individual Project/DB Capital Budgeting Janella Chapman ACCT-614/Applied Managerial Accounting March 15, 2013 Professor Tracie Edmond I. Overview As companies look to grow and expand operations, product lines, or locations, capital budgeting is the method used by management in evaluating if projects and long-term investments will be profitable for the company. Capital budgeting analysis evaluates projects that will have cash flows for longer than a year. Capital budgeting helps management analysis if investments will be profitable and valuable to the company compared to the initial investment needed and the risk associated with the investment. There are many capital budgeting methods management may use to ensure the project or investment is aligned with the corporate strategy of a company. In the capital budgeting process, management evaluates different capital budgeting techniques to ensure the company has the resources to invest in the project, and also helps management determine if the investment will help achieve the goals and objectives of the company. The goal of capital budgeting is to evaluate the costs of an investment to the initial capital to determine if the investment will generate more capital or cash flow for the company. The four capital budgeting techniques used by management are Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), and Payback method. SAC has developed new manufacturing techniques to offer special...
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...Name: Professor’s name: Dr. Wright Course: AF 211 Accounting for Planning and Control Managers in making investment decisions are faced with the problem of limited resources. This, therefore, necessitates an understanding of the topic of capital budgeting. Capital budgeting is the process of determining and pursuing investments which cash flows are expected in the future period usually more than a year. It entails the decision on the acquisition of new assets or equipment that is to be utilized by the business to increase its future cash flows and profitability. Managers are, therefore, faced with the challenge of determining which project to invest in order to avert the adverse effect on the financial performance. In making investment decisions, various factors must be considered. Managers have to know that the success of the business entirely depends on how best the investments are analyzed before they are undertaken. First, capital budgeting requires large capital outlay (Dugdale 16). Most of the capital budgeting decisions require a large proportion of business funds. It, thus, implies that failure to make proper investment decisions will lead to losses for the organization. Secondly, investment decisions are irreversible. After deciding on what projects to invest in, managers will lack the ability to reverse their decisions, i.e., equipment once acquired cannot be easily disposed of. The managers must therefore be careful before settling on a particular investment...
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...CHAPTER ONE Introduction Understanding and being able to use capital budgeting techniques and investment appraisal tools is usually a standard requirement for most business degrees. In addition learning such methods will also give one an advantage in a real business situation, in which there is the consideration of significant capital expenditure project. Capital budgeting assists management decisions making on the process of ensuring growth of the organization. The techniques are divided into two types: one, Traditional (non-discounting) that includes pay back method, accounting rate of return (ARR). Two, discounting cash flow that includes net present value (NPV), internal rate of return (IRR) Profitability Index (PI). Before an investment appraisal is conducted, there are a number of points to keep in mind. Whilst the tool presented will give an evaluation of the worth of a project, one should consider that the answer is only a guide. In short, the results of an investment appraisal should be considered in conjunction with both common sense and other qualitative factors such as a business’s overall strategy. Secondly, before an investment appraisal is conducted, one should consider whether or not the project is mutually exclusive. Where a project is mutually exclusive, then only the best project should be selected. Where on the other hand, projects are independent; one may select all projects which give the appropriate return. 1.1 Background of the study Corporate finance...
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...and equity options are available to Fantasy Airlines to finance this fleet purchase. Considering the advantages and disadvantages of all options, we will review our results separately with every option available. Basic investment appraisal techniques that will be used in the analysis will include: • Net Present Value • Accounting Rate of Return • Internal Rate of Return • Payback Period • Profitability Index The following assumptions are necessary for our investment analysis: • Option 1: Cost of capital (in case of debt) = 1.15% • Option 2: Cost of capital (in case of equity) = 1.5% • Option 3: Cost of capital (in case of preferred shares) = 1.25% • Option 4: Weighted average cost of capital (in case of 50% debt, 25% preferred shares and 25% equity) = 1.18% Net Present Value Net present value is capital budgeting technique, which emphasizes that the bottom line net present value should be positive after all obligations are met. Option with highest net present value is the most viable one. The estimated future cash-flows are discounted today with a certain cost of capital to calculate the present value after which initial outlay is deducted from the present value to calculate net present value. | |Option 1 |Option 2 |Option 3 |Option 4...
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... 2. Compare and criticize capital budgeting methods? Which method do you recommend for use? Explain why? An operating budget consists of the known expenses, expected future costs, and forecasted income over the next year (Bradford, 2015). The eight items listed on the check list are important for managers to consider when reviewing an operating budget in order to properly evaluate the financial performance of the organization. There is not a single correct way to prepare an operating budget, and its development depends on several individual factors of the organization. For example, a static budget is based on a single level of operations and the budgeted expense amounts never change. Static budgets can be used to plan and set goals. A flexible budget projects expenses at various levels of activity, and is adjusted to the actually level of output reached during the period. Flexible budgets can be used to review previous performance of difference volumes. It is important that a manager is able to understand whether the budget is either static or flexible. If a cost is fixed, it does not change even if the volume changes. Variable costs increase or decrease proportionally to the volume change. A manager needs to know whether a budget’s costs are considered fixed or variable (Baker & Baker, 2014). Cash flow reporting is an important tool used when constructing a capital expenditure budget. However, there are four different capital budgeting methods that can be used to report...
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...1 HOTEL OWNER / OPERATOR STRUCTURES: IMPLICATIONS FOR CAPITAL BUDGETING PROCESS Chris GUILDING Service Industry Research Centre, and School of Accounting and Finance Griffith University – Gold Coast Campus Queensland AUSTRALIA C.Guilding@griffith.edu.au Tel: (07) 5552 8790 Fax: (07) 5552 8068 I am grateful for funding support for this study provided by the Australian Cooperative Research Centre for Sustainable Tourism. I would also like to acknowledge the helpful comments and suggestions provided by two anonymous referees. 23 HOTEL OWNER / OPERATOR STRUCTURES: IMPLICATIONS FOR CAPITAL BUDGETING PROCESS ABSTRACT The findings of a field study concerned with appraising capital budgeting process implications arising from different owner / operator structures employed in the hotel industry are reported. Dimensions of conflict that can arise between hotel operators and owners are examined. Consistent with expectations motivated by agency theory, data collected suggest that capital budgeting systems in hotels operating under a divorced owner / operator structure exhibit more formalisation and a greater propensity for investment proposal cash forecast biasing. These findings suggest a degree of dysfunctionalism associated with the divorced / owner operator structure widely adopted in the hotel industry. Key words: Hotel, Capital Budgeting, Ownership structure, Agency theory.4 ...
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...Management J. Volume 2 No. 1 (January 1989) ,' CAPITAL BUDGETING PRACTICES OF INDIAN COMPANIES I. M. PANDEY ' Objective " The objectives of this study are: (a) to document the capital bud geting policies and practices of companies in India, a developing country, and contrast them with those of USA and UK, the developed countries, and (b) to ascertain how business executives look upon the linkage between corporate strategy and investment decision-making. Capital expenditure planning and control is a process of facilitating decisions covering expenditures on long-term assets. Since a company's survival and profitability hinges on capital expenditures, specially the major ones, the importance of the capital budgeting process cannot be over-emphasized. Sample and Methodology We have followed an intensive interview-cum-questionnaire method. Two questionnaires—one dealing with investment evaluation practice and second with other phases—were sent to companies which had agreed to participate in the study. In all, 14 companies were studied. The responding companies belonged to different businesses. In terms of size (sales and number of employees), capital intensity (net tangible fixed assets), volume of spending (capital expenditure incurred), and level of technology, they represent a variety (Table 1). The study relates to 1984. •-, Capital Expenditure: How Defined Strictly speaking, capital expenditure includes all those expenditures which are expected to produce...
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...Handouts for Corporate Finance 1 Capital Budgeting Introduction A logical prerequisite to the analysis of investment opportunities is the creation of investment opportunities. Unlike the field of investments, where the analyst more or less takes the investment opportunity set as a given, the field of capital budgeting relies on the work of people in the areas of industrial engineering, research and development, and management information systems (among others) for the creation of investment opportunities. As such, it is important to suggest that students keep in mind the importance of creativity in this area, as well as the importance of analytical techniques. Because a project is financially sound, it must be ethically sound, right? Well . . . the question of ethical appropriateness is less frequently discussed in the context of capital budgeting than that of financial appropriateness. Consider the following simple example: The American Association of Colleges and Universities estimates that 10 percent of all college students cheat at some time during their postsecondary education careers. You might pose the ethical question of whether it would be proper for a publishing company to offer a new book How to Cheat: A User's Guide. The company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The...
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...SUMMARY OUTLINE CAPITAL BUDGETING PRACTICES OF INDIAN COMPANIES Introduction Corporate strategy provides the focal point for the firm's long-run strategic planning. The capital budgeting system, particularly for large strategic projects, is determined in the context of strategic planning and, thus, it is a top-down process. Corporate strategy and strategic planning play the most crucial role at the identification and evaluation phases. Operating and administrative capital budgeting decisions can be decided at lower /middle level of management within the overall strategic framework and guidelines from top management. The capital budgeting system at lower/middle level will largely be a bottom up process. It may be noted that external and internal environment provides a context to the company to establish and review its missions, concerns, and multiple objectives which, in turn, shape its corporate strategy. Objectives There are two objectives of this study: a) To document the capital budgeting policies and practices of companies in India, a developing" country, and contrast them with those of USA and UK, the developed countries b) To ascertain how business executives look upon the linkage between corporate strategy and investment decision-making. Sample and Methodology The study used interview-cum-questionnaire method and sent to 14 companies different businesses which had agreed to participate in all. Methods of Evaluation The study was...
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...Risk Management in Capital Budgeting Process Introduction: Capital investment decision, like the capital budgeting process, includes series of analysis and decision making processes that have long term impact on the company. Any investment conducted for future net cash growth by company’s management, regardless of investing in intangible or tangible assets can be described as capital budgeting. Company management has obligations towards company owners to increase company wealth. Risk has been recognized as an important component in the capital budget decision making. The future is uncertain and investments techniques that fail to recognize this fact will almost certainly lead to incorrect conclusions and erroneous recommendations. In today’s uncertain and unpredictable global market, where technical, technological and economic development speed is rapidly increasing, selection of optimal process and selection of optimal project is significantly difficult. In many respects, capital budgeting defines an organization’s leadership. Capital budgeting decisions establish strategic priorities, allocate managers to assemble and communicate information across traditional organizational boundaries, for example, marketing, engineering, production, and accounting. The information is evaluated within a rational cost/benefit decision framework by analyzing cash inflows and outflows over time. In project selection process, corporate manager uses various criteria and methods in selecting...
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...the function of capital markets, the valuation of real assets and financial assets. Discounted cash flow analysis(DCF) is a tool that derived from finance theory which has been widely used. However finance theory also has little effect on strategic planning and there are three differences between financial theory and strategic planning: 1. Traditional financial theory and strategic planning might have some differences in language and culture. 2. Discounted cash flow analysis might be used in an incorrect way of strategy therefore it is not acceptable in terms. 3. Discounted cash flow analysis might fail to apply a strategic, even if it is used properly. The most relevant financial concepts in strategic planning is firms’ capital investment decisions and it is also a critical component of “financial theory”. The theory is focused on cash flow and return on the investment. The tool used in investment decisions is net present valued (NPV) which was calculated from present valued minus required investment or which was reduced to discounted cash flow formula because the net present value is a matter of cash flow that will gain in the future. [pic] The company is comprised of tangible assets and intangible assets including growth opportunities. The Intangible assets and this growth is a clear reflection of the stock prices and was used to evaluate the capital budgeting analysis will...
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...The misapplication of capital investment appraisal techniques Colin Drury Professor, University of Huddersfield, Huddersfield, UK Mike Tayles Lecturer, University of Bradford, Bradford, UK Surveys of capital budgeting practices in the UK and USA reveal a trend towards the increased use of more sophisticated investment appraisals requiring the application of discounted cash flow (DCF) techniques. Several writers, however, have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. Such claims have been made on the basis of observations in only a few companies, or anecdotal evidence, without any supporting statistical evidence. Reports on a recent survey conducted by the authors which suggests that many UK firms are guilty of misapplying DCF techniques. Also provides evidence relating to some issues that have not been thoroughly examined in previous studies, namely the impact of company size and the relative importance that firms attach to different investment appraisal techniques. An examination of the surveys of capital budgeting practices that have been undertaken during the past 20 years in both the UK and USA reveals a trend towards a continuing increase in the use of more sophisticated capital budgeting techniques. In a longitudinal survey of capital budgeting practices of large UK companies between 1975 and 1992 Pike (1996) reported a substantial increase in the usage of discounted cash flow (DCF) and risk appraisal techniques. In 1975...
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...Capital Budgeting Introduction A logical prerequisite to the analysis of investment opportunities is the creation of investment opportunities. Unlike the field of investments, where the analyst more or less takes the investment opportunity set as a given, the field of capital budgeting relies on the work of people in the areas of industrial engineering, research and development, and management information systems (among others) for the creation of investment opportunities. As such, it is important to suggest that students keep in mind the importance of creativity in this area, as well as the importance of analytical techniques. Because a project is financially sound, it must be ethically sound, right? Well . . . the question of ethical appropriateness is less frequently discussed in the context of capital budgeting than that of financial appropriateness. Consider the following simple example: The American Association of Colleges and Universities estimates that 10 percent of all college students cheat at some time during their postsecondary education careers. You might pose the ethical question of whether it would be proper for a publishing company to offer a new book How to Cheat: A User's Guide. The company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The book would sell for $7.50 per copy and...
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...Capital budgeting Making decisions having significant future benefits or costs for various entities and their stakeholders. Capital budgeting is the backbone of financial economics. Related topics in financial economics include: the time value of money, the meaning of net-present value, accounting concepts consistent with present-value calculations, discount rates, and option valuation techniques. In the public sector, the term is often exclusively associated with infrastructure investments -- plant and equipment. It is more properly associated with all policy choices that have significant, long-term consequences: especially decisions about missions, programs, products, processes, or procedures. There are standard solutions to several kinds of capital-budgeting problems: make or buy decisions, investment in working capital (especially inventories) decisions, maintenance-level decisions, project selection, the choice of mutually exclusive investments, and investments in plant with fluctuating rates of production. However, the same basic calculus of benefits and costs is supposed to guide all classes policy choices with long-term consequences. Financial Theory Financial theory teaches that, in the presence of a capital market where funds can be obtained at a price, welfare will be maximized by the implementation of all policy choices that generate positive net-present values. This means, in part, that the timing of benefits and costs is generally of no...
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...Management Blekinge Institute of Technology THE IMPORTANCE OF THE PAYBACK METHOD IN CAPITAL BUDGETING DECISION. By Alaba Femi, AWOMEWE & Oludele Olawale, OGUNDELE Supervisor: Anders Hederstierna Thesis for the Master’s degree in Business Administration Fall/Spring 2008 THE IMPORTANCE OF THE PAYBACK METHOD IN CAPITAL BUDGETING DECISION. By Alaba Femi, AWOMEWE & Oludele Olawale, OGUNDELE A thesis submitted in partial fulfillment of the requirements for the degree of MBA (Master of Business Administration) Blekinge Institute of Technology 2008 Supervisor Anders Hederstierna ii Abstract Title: The importance of the Payback method in Capital budgeting decision. Authors: Alaba Femi, Awomewe and Oludele Olawale, Ogundele Supervisor: Anders Hederstierna Department: School of Management, Blekinge Institute of Technology Course: Master’s thesis in business administration, 15 credits (ECTS). Background and Problem Discussion: The capital budgeting decision has been a very typical issue in the sustenance of a company. Several companies have lost their identity or liquidated due to wrong capital budgeting decision they made at one particular time or the other. Based on these prevalent problems in industries and the effect of globalisation on industries, it is important to use effective method to analyse investment before decision is made. Capital budgeting is extremely important because the decision made involve the direction and opportunity...
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