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Evaluation of Four Capital Budgeting Techniques

Compare each capital budget technique, showing the advantages and disadvantages of each. Should the manager select just one? Why or why not?

Solution Preview

Capital budgeting techniques are procedures for making decision about whether to purchase assets that will serve multiple years. Multi-year projects are important because they span many periods and so impact a firm for many business cycles but also because they are large dollar amounts and therefore can be critical to success. There are four classic techniques for avoiding projects that will not improve the firm's profits and cash flows and therefore should be rejected from consideration. Each has their own advantages and disadvantages. Many managers, rather than insist on one of these techniques, will review several (or all) of these when reviewing a project. The multiple-view method is easy with modern spreadsheet tools that make the computations easy and inexpensive and thus the manager can have the 'best of all worlds" at lost cost. Let's review each technique.

NPV

Net present value is a method where the manager forecasts future cash flows, net of tax, and then discounts those future flows to the present. The present value is compared to the initial investments and the "net" of these two is NPV. NPV advantages include having a ...

Solution Summary

The solution gives the advantages and disadvantages of the four capital budgeting techniques - NPV, PI, IRR & Payback - and explains why modern managers do not select just one. 773 words with 2 references.

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