Capital Budgeting Methods for Corporate Project Selection

Capital Budgeting Methods for incorporate Project Selection In a 2001 Graham and Harvey survey of 392 chief financial officers (CFOs) asked how frequently they use different capital budgeting methods? Approximately 75% of the CFOs replied that they use net present value (NPV) or familiar Rate of Return (IRR) always or almost always (Smart, Megginson & Gitman, 2004, pg. 251). Projects atomic number 18 viewed as capital investments in the corporate world, and as such, are evaluated closely for their possible financial impacts on the bottom line collectible to their higher riskiness of failure.Capital investments are those that are considered long-term investments such as manufacturing plants, R&D, equipment, marketing campaign, and so forth , and capital budgeting is the process of identifying which of these investment go fors a firm should undertake (Smart, Megginson & Gitman, 2004, pg. 227). According to Smart, Megginson & Gitman, there are deuce-ace steps in the capital budg eting process * Identifying potential investments Analyzing the set of investment opportunities, identifying those that give create stockholder value, and perhaps prioritizing them * Implementing and Monitoring the investment estimates selected This paper will focus on step two, and will reason the strengths and weaknesses of the quadruple most common methods that are utilized for evaluating, selecting and prioritizing projects in the corporate world. Net Present respect (NPV), Internal Rate of Return (IRR), Straight/Discounted Payback Period and Profitability Index are the quaternary of the most come methods used during step 2 of the capital budgeting process.Four fictional potential capital investments will be used to illustrate how the different methods can affect project selection for a portfolio. study PARK CAPITAL INVESTMENTS A theme park senior executive management team had four capital projects presented during the last capital budget meeting. The projects are a $250M park expansion, $50M value resort renovation, $500M recent moderate resort construction and $200M new value resort construction. All these projects have similar apogee epoch frames and have 20 year life expectancies.Years 1 to 5 cash flows for each project come from the pro formas, and Years 6 -20 are based on an expected 2% per enlarge in cash flows. The company has $750M to invest on capital projects this year, and they must decide which projects should be approved. kale PRESENT VALUE Net Present Value is the sum of discounted future cash flows and provides the appropriate adjustments for the time value of money. In short, NPV is the reverse of compounding interest, and this process begins with the selection of a discount rate. According to Smart, Megginson & Gitman, pg. 01, A projects discount risk must be high enough to compensate investors for the projects risk The discount rate can be based on the inherent risk of a project, the required rate of return on shares, cost o f equity, etc. The discount rate should not be one rate for all projects with in a firm, but reflect the nature of the project. The mandate for NPV is In this calculation, CFt represents the net cash flow of the year and r is the selected discount rate. CF0 usually represents the initial cost to get the project started, and is usually a negative cash flow.As a rule, projects with a negative NPV are not approved, but a hurdle could be set such as projects with a NPV