Financial Management Assessment

Introduction

Capital Budgeting: Applications of Investment Decision Techniques

Making a capital budgeting decision is one of the most important policy decisions that a firm makes. A firm that does not invest in long-term investment projects does not maximize stakeholder wealth. Capital budgeting decisions determine the future of the company. An appropriate investment decision can yield spectacular returns. On the other hand, a misguided and incorrect decision can endanger the very survival of the firm. A few wrong decisions and the firm may be forced into bankruptcy.

Capital budgeting decisions generally are either replacement decisions or expansion decisions. Replacement decisions are for purchasing of assets to replace existing assets that might be worn out, damaged or obsolete. Expansion decisions are made to add capital projects to the existing assets so as to produce either more of its existing products or entirely new products. Capital budgeting decisions are deciding which projects a firm should accept and which it should reject. Various capital budgeting techniques like payback, discounted payback, net present value (NPV), internal rate of return (IRR) and profitability index may be used to arrive at the most suitable decisions.

The selected case intends to give you an insight into selecting capital investments projects using two investment decision techniques: net present value (NPV) and internal rate of return (IRR). This case gives you an opportunity to have hands-on experience in applying the selection techniques on seven projects with different cash outlays but the same period of life.

The case has four primary learning objectives:

1. Explain the mechanisms of capital investment decisions.
2. Identify the appropriate investment decision techniques suiting the characteristics of the projects.
3. Apply the capital investment decision techniques on seven projects with different cash outlays.
4. Demonstrate the ability to evaluate the various capital investment projects and make decisions based on their merits, and availability of funds (capital rationing).

Task

After reviewing the appropriate readings and learning materials, please answer the given questions of the selected case study:

1. Rank the projects simply by inspecting the cash flows (you must calculate the sum of cash-flow benefits and the excess of cash inflows over cash outflows).
2. Rank the projects using two quantitative methods: NPV and IRR. Assume that all projects are from the same risk class and the appropriate discount rate is 9%. Briefly explain the two methods and specify which quantitative ranking methods are better, and why.
3. Compare the ranking obtained by the two methods with the ranking obtained by simple inspection of the cash flows. Do they differ? Explain the reasons why they differ or not.
4. Recommend the ‘best projects’ that the firm should accept when the funds available are limited to AED 65 million, and Project 4 and Project 5 are mutually exclusive.

Are you struggling to keep up with the demands of your academic journey? Don't worry, we've got your back! Exam Question Bank is your trusted partner in achieving academic excellence for all kind of technical and non-technical subjects.

Our comprehensive range of academic services is designed to cater to students at every level. Whether you're a high school student, a college undergraduate, or pursuing advanced studies, we have the expertise and resources to support you.

To connect with expert and ask your query click here Exam Question Bank