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Three Capital Budgeting Techniques

In finance, it is important not only to understand how to use various calculations, but also to know the limitations of these calculations. This is the purpose of the ongoing discussion.

You have learned about the three capital budgeting techniques financial managers use to make decisions about capital expenditures.

What are the limitations of each of these methods?
How can financial decision-makers avoid these limitations when utilizing these tools?

Solution Preview

1. The required rate of return is difficult to calculate, although more and more companies are using the capital asset pricing model or CAPM to compute for the cost of capital or weighted average cost of capital, the company's WACC can significantly differ from the project's cost of capital. To resolve this issue, decision makers can compute for NPV using a range of rate of returns including company, competitor and industry WACC; and of similar projects whether within or outside the company. This can also be resolved by using ...

Solution Summary

The limitations of the three capital budgeting techniques on capital expenditures are discussed.