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Use of capital budgeting techniques in strategic management

Using net present value, determine the proposal's appropriateness and economic viability.

Prepare a report explaining your calculations and conclusions. Answer the following in your report:

o Explain the effect of a higher or lower cost of capital on a firm's long-term financial decisions.

o Analyze the use of capital budgeting techniques in strategic financial management.

ยท Format your report according to APA standards.

Proposal C: New Advertising Program

A company wants to invest in a new advertising program. Using the NPV method of capital budgeting, determine the proposal's appropriateness and economic viability with the following information:

? The new program will increase current sales, $10 million, by 20%.
? The new program will have a profit margin is 5% of sales.
? The new program will have a 3-year effect.
? The new program will cost the company $200,000 in the first year.

Solution Preview

o Explain the effect of a higher or lower cost of capital on a firm's long-term financial decisions.
Cost of capital is an expression of this cost and is used to see if certain intended investments or strategies or projects or purchases are worthwhile to undertake. (Valuebasedmanagement, 2009)
It is the weighted average cost of all the funds of the organization such as debt and shares. It would consider the following factors:
-Risk appetite of the management
- Future Capital requirements
-Degree of operating leverage
-Economic scenario
-State of business cycle
-Cost of funds
Cost of capital affects capital budgeting or firm's long term financial decisions considerably. Higher cost of capital will make investments costly and net present value of the project will reduce. Similarly Lower cost of capital will make investments cheaper and net present value of the project will increase. But we must understand that each capital budgeting project has its own unique risk. Some projects can have higher fixed costs. Thus business risks increases with the increase in operating fixed costs. On the other hand financial risk comprises the risk of using debt and meeting the interest expenses.
Hence different projects have different risks. Therefore it's appropriate to have different discount rates for different projects. One should use Risk adjusted ...

Solution Summary

Response helps in guiding about the use of capital budgeting techniques in strategic financial management

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