Capital Budgeting

Capital Budgeting

Introduction

Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the firm’s goal of maximizing owner wealth. A firm using capital budgeting, their goal is to see if there fixed income will cover itself for profit. Fixed incomes are things such as land, plant and equipment. When a firm using a machine to produce its good or service. They most of the time what the machine to

produce the amount that they paid for the machine and more. The capital expenditure is the outlay of fund that a firm expects to produce and benefit with in a one year.

The Capital Budgeting Process

When approaching the problem of trying to the measure capital budgeting. The first step in capital budgeting is the Proposal generation. The proposals are made at all levels within a business organization and are reviewed by finance personal. The Second step in the process in the review and analysis. The formal review and analysis is performed to assess the appropriateness of proposals and evaluate their economic viability. Once the analysis is complete, a summary report is summated to decision makers. The third step in the process will be the Decision making. Firms typically delegate capital expenditure decision making on the basis of dollar limits. The board of directors must authorize expenditures beyond a certain amount. Often plant manager are given authority to make decisions necessary to keep the production line is moving.

The forth step in the capital budgeting process is the Implementation. This process involves expenditures that come from projects implemented. Expenditures for a large project often in these phases. The final step in the process will be the follow-up stage. Results are monitored and tell the actual outcomes.

Sunk cost and Opportunity Cost

Doing the time of estimating the relevant cash flows associated with a proposed capital expenditure, the firm must recognize any sunk cost and opportunity cost. When determining projects incremental cash flows. The suck costs are cash outlays that have already been made and have no effect on the cash flows.

The opportunity costs are cash flows that could be realized from the best alternative use of an owned asset.

Net present Value (NPV)

The NPV gives explicit consideration to the time value of money. The NPV is considered a sophisticated capital budgeting technique. The NPV is measured by subtracting a project’s initial investment from the present value of the cash inflows discounted at a rate equal to the form cost of capital. The NPV measures inflows and out flows. When putting your input in to the chart. The chart requires the amount of years that the firms think it will take to retrieve its investment. The input of the out flow is entering in to the charts as a negative. The reason why the number is entered as a negative is because that is the amount of money the firm is giving out to pay for the machine.

INPUT

LIFE OF PROJECT

5

DISCOUNT RATE/ REQUIRED

RATE OF RETURN (i) 8.000%

CASHFLOWS ($$) (58,300.00) 19,080.00 15,900.00 26,500.00 10,600.00 8,480.00

YEAR 0.00 1.00 2.00 3.00 4.00 5.00

Recaptured Depreciation

Recaptured depreciation is the portion of an asset’s sale price that is above its book value and below its initial purchase price. When a firm uses this method they are simple taking an old machine and selling it for more then the current worth. We will now look at an example of “recaptured depreciation”. A few years ago, Ransack Industries implemented an inventory auditing system at an installed cost of $159,000, has taken depreciation totaling $112,890. If Ransack sold the system for $$99,852, how much recaptured depreciation would result? Recaptured depreciation=Sale price-Book value, Book value=Installed cost of the asset-Accumulated depreciation,

INPUT

Installed Cost = 159,000

Depreciation = 112,890

Selling Price = 99,852

=