Primary methods of capital budgeting
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The CEO has given you 3 different large projects he's evaluating to see which might be most beneficial to the company to invest in. These include:
A new labor-saving piece of equipment that cost $400,000 and will reduce labor and quality costs by $75,000/year for 6 years.
A new marketing program, costing $500,000 is expected to increase current sales of $10,000,000/year by 30% for the next 4 years only. The current contribution margin of 30% will remain in effect even with this sales increase.
Launching a new product will cost $600,000; the product is expected to sell for $15/unit at a volume of 20,000 units/year for 3 years, at a 40% contribution margin.
The firm's overall cost of capital is 10%.
As a follow up to your capital budgeting analysis, the CEO asked you to write a memo addressing these specific questions:
Why does a firm need to have a capital budgeting process?
What is/are
-¦the 3 primary methods of capital budgeting?
-¦the pros and cons of each?
-¦the method you feel is the best and why do you think so?
Is it better for the firm to have a higher or lower discount rate (or cost of capital)? Why?
What could happen if you pick a discount rate that is too high?
** DETAILS ARE ATTACHED IN EXCEL **
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Response discusses the primary methods of capital budgeting
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The CEO has given you 3 different large projects he's evaluating to see which might be most beneficial to the company to invest in. These include:
A new labor-saving piece of equipment that cost $400,000 and will reduce labor and quality costs by $75,000/year for 6 years.
A new marketing program, costing $500,000 is expected to increase current sales of $10,000,000/year by 30% for the next 4 years only. The current contribution margin of 30% will remain in effect even with this sales increase.
Launching a new product will cost $600,000; the product is expected to sell for $15/unit at a volume of 20,000 units/year for 3 years, at a 40% contribution margin.
The firm's overall cost of capital is 10%.
I have checked the calculation. I have also included the computation of payback period.
As a follow up to your capital budgeting analysis, the CEO asked you to write a memo addressing these specific questions:
Why does a firm need to have a capital budgeting process?
Capital budgeting is about investment decision of the organization. For understanding this in detail, let us know the basic capital budgeting steps (financingcp, 2009):
1) Identify potential projects
2) Evaluate and compare projects
For this one has to do the technical, organizational, regulatory, and financial evaluation
3) Select project(s) to implement
Financial evaluation and comparison of the project
It helps in selection of the appropriate project/s for the organization.
What is/are ...
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