Differences in Capital Budgeting Alternatives

Capital budgeting is a process where a firm looks at a set of cash flows from a project over the years to determine whether to accept or reject a project. It is called Capital Budgeting since these projects are capital investments- investments with a useful life of over one year and are significant obligations to the firm.

While there are a variety of methods to perform this analysis, the main techniques are:

• Payback
• Net Present Value
• Internal Rate of return.

For each:

1. Describe each method's advantages and disadvantages from the company's standpoint as they seek to decide whether to accept a project or reject a new capital budgeting project.
2. Describe the effect on each method, in general, if the interest rate a firm pays increases from 2% to 4%.