Capital Budgeting Simulation
Summary of Financi

Capital Budgeting Simulation

Summary of Financi

In each and every category, Corporation B has a more positive result. Unquestionably this would be the better purchase choice.

The most respected of the project assessment indicators, net present value is the amount that you would need to pay now to obtain the future stream of cash flows that the project would produce. It is particularly useful when dealing with a project that will require investment over a period of time, or will take a while to become profitable. It also shows the total dollar value of the project, rather than a percentage. This makes it easier to maximize the total dollar result of an investment portfolio rather than maximizing one indicator.

Corporation B has a much higher net present value, despite the fact that it was calculated using a higher discount rate. The main reason for this is the slower rate of increase of costs relative to the increase in revenues than is present in Corporation A. Corporation B’s higher depreciation expense also results in more tax benefits, further increasing its net present value.

This indicator is very popular when handling large numbers of small projects or attempting to remove projects that do not perform well from consideration. It is calculated by determining the interest rate at which the net present value of the project is zero. Using the IRR allows the manager to see how well each project uses its funds, rather than simply comparing the activity against a pre-set required rate of return. It is also possible to compare the IRR’s of projects with different duration.

It is possible, however, for an IRR calculation to overlook projects with a positive net present value at the company’s cost of capital. This is a particular danger when used only to analyze part of a project’s life. In the comparison of these two companies, however, the company with the higher net present value is also the one with the higher IRR, so these two indicators support each other…

Leave a Reply

Your email address will not be published. Required fields are marked *