Please asap i have only 30 minutes. answer in your own terms ASAP  SUBJECT: BU Finance I

Capital Budgeting Techniques

Your peer response should be specific to what was posted. Give an opinion of each clasmmate post:

1.Classmate post:

The first of the three main types of capital budgeting involves Net Present Value (NPV). The NPV demonstrates how much a firm's value will increase with a purchase of a capital budgeting project. It is calculated by using the difference in net cash inflows and net cash outflows over a period of time. The main goal is to locate which projects will generate the most profit. NPV has the advantage that it is straightforward to calculate, being able to use a spreadsheet or a financial calculator. This technique also recognizes the time value of money, unlike simple payback periods. NPV also works for all types of investment sizes, large or small. However, Net Present Value assumes that the discount rate remains constant through the investment life cycle. Similar to interest rates, discount rates are subject to change from year to year. Additionally, opportunity costs change and differ for each investor which can cause stray results. NPV also assumes that one can accurately assess and predict future cash flows which sometimes proves random. (Forisk) Lastly, NPV cannot compare two projects of different sizes due to the NPV method results in an answer in dollars, the size of the output is correlated to the size of the input. (Nasdaq).

Internal Rate of Return (IRR) is another type of capital budgeting technique in which the rate of return the firm expects to earn if the project is purchased and held for its useful life. In essence, a projects IRR is its yield to maturity (Chapter 9). This method is ideal to use when comparing multiple factors to rank them from most to least beneficial in a singular project. Additionally, it takes into consideration the time value of money which allows every cash flow to be assigned equal rates. This gives solid percentages in which you can rank ideas for your specific project. However, the IRR ignores the size and scope of the project. It only considers profitability in the short term. This poses problems becomes it steers the business away from making long-term decisions that will result in higher profits compared to short-term ones. The IRR also does not consider future costs that come with a growing business. It keeps the costs of the business remaining constant allowing for other costs to sneak up on a person in the result. Lastly, the IRR does not account for reinvestments and future investors, only the initial investment.

The oldest method of capital budgeting projects concerns the payback period (PB). This is defined as the length of time it takes to recover the original cost of investment from its raw cash flows (Chapter 9). The most noticeable advantage of this method is its simplicity and quick solution. This is favorable to others because it is easy to understand and comprehend. It is useful in cases of uncertainty and has a liquidity preference. These are all for small businesses with little resources that cannot have large margins for error due to fear of bankruptcy. This simple formula does have repercussions in the sense of how unrealistic it is. It does not take into consideration irregular cash flows. The PB only focuses on when the initial investment is recovered and nothing after. It also only focuses on the short term, taking the quickest option to recover its investment. The quickest option may not be the most profitable indefinitely.

If I were to use one of these three methods in a presentation to a senior management team, I would choose the payback period. If the group were in fact finance gurus, one might choose the NPV. However, in this instance, I could imagine that the group would want the simplest and easiest explanation on how to gain their 2 million back. The payback period gives them a simple answer on how long this investment should be received, giving them relief from uncertainty. Its use for long years also gives them a sense of courage that this ideology can be trusted.

2.Classmate post:

There are three major types of capital budgeting techniques. They are net present value, internal rate of return, and the traditional payback period. All three of these techniques have advantages and disadvantages. The first technique is net present value lets you know whether the value of all cash flows that a project generates will exceed the cost of starting that project. We have graphs that show NPVs for projects at discount rates. The next technique is internal rate of return this is the discount rate that forces the PV of a projects expected cash flows to equal its initial cost (Besley & Brigham, 2021). Internal rate of return is an estimate of a future annual rate of return. The last technique is the traditional payback period is the length of time it takes to recover the original cost of an investment from its unadjusted expected cash flows. In other terms its the years required to recover the original investment.

The advantages of net present value are that it is a good measure of profitability, it factors risk, and it accepts conventional cash flow patterns. There are also disadvantages there is difficulty in determining the required rate of return, it ignores sunk cost, and it estimates the opportunity cost. There are also some advantages too internal rate of return it finds the time value of money, it is simple to use and hurdle rate is not required. It also has some downsides though, it ignores size of project, it doesnt consider future cost, and it ignores reinvestment rates. The traditional payback period is very common and has many advantages, the formula is straight forward, easy to calculate, it helps in project evaluation quickly. Like the other two techniques it has some disadvantages, it doesnt take time value of money into consideration, not all cash flow is covered, and it ignores profitability.

If I were working on a presentation to senior management, I would use the traditional payback period. It is very simple method to calculate the period required and because of its simplicity it does not involve much complexity and helps to analyze the reliability of project. The biggest downside is that the traditional payback period ignores the time value of money