Guillermo Furniture Capital Budget Recommendation Essay example

This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period, discounted payback period, NPV, IRR, MIRR,

Internal Rate of Return is a discount rate in which the net present value of an investment becomes zero. The investment should be accepted if the IRR is not less than the cost of capital. The IRR measures risk, by showing what the discounted rate would have to reach to lose all present value. Futronics Inc. investment would have an IRR of 14.79%. The investment should be accepted since it is greater than the 8% cost of capital. The 14.79% IRR shows the growth expected from the

There are different types of budgeting that businesses typically use and those include Operating budgets, Capital Budgets and there are many subtypes that exist because a budget can also be created for special events, the recruitment and retention of new staff, and to manage the advertising expenses and return on investments for a business (Demand Media, 1999-2012). According to Demand Media (1999-2012), "An operating budget outlines the total operating expenses and income for the organization, typically for the period of a fiscal year. Capital budgets evaluate the investments and assets of the business, and a cash budget shows the predicted cash flow in and out of the business over a period of time” (para.2 ). According to the Cost-Benefit Analysis (2012), “Capital budgeting has at its core the tool of cost-benefit analysis; it merely extends the basic form into a multi-period analysis, with consideration of the time value of money. In this context, a new product, venture, or investment is evaluated on a start-to-finish basis, with care taken to capture all the impacts on the company, both cost and benefits. When these inputs and outputs are quantified by year, they can then be discounted to present value to determine the net present value of the opportunity at the time of the decision” ("Cost-Benefit Analysis," 2012).

EEC calculated the amount of time involved the anticipation of its cost ($3 million). The timeline in recovering their cost of investment ($2 million) initially for the foundation of this investment any profit made in the future of this investment will be justified as a profit for the company. If EEC can anticipate a fast return on its investment it is a profitable wise decision in making the investment financial, it is considered to be an easier way of formulating investments financially. On the basis of one year all cash flows is added together equal to the sum of $2 million originally invested, then it is divided by the annual cash flow of $500,000. The calculation of the payback period would equal four years. After this time frame any financial proceeds will be considered profitable for the company. I conclude that the timeframe is adequate in comparison of the investment in this worthwhile investment financial venture for the company.

The weighted average cost of capital (WACC) is one of the most important figures in assessing a company’s financial health as it gives an insight into the cost of the financing, can be used as a hurdle rate for investment decisions, and acts as a measure to be minimized to find the best capital structure for the company (QFinance the Ultimate Financial Resource, 2011).   The WACC for the high-tech alternative is 9.056% and represents the rate of return that the investors of Guillermo Furniture require, weighted according to the proportion each element of debt and equity bear to the total pool of capital.   The Guillermo weighted mix of financing is 40% debt and 60% equity. This alternative produces a 12% return on equity, so with the WACC of 9.056%, it creates almost 3% additional value for its investors.

NPV is known as the best technique in the capital budgeting decisions. There were flows in payback as well as discounted pay back periods because it don’t consider the cash flow after the payback and discounted pay back period. To remove this flows net present value (NPV) method, which relies on discounted cash flow (DCF) techniques is used to find the value of the project by considering the cash flow of the project till its life. To implement this approach, we proceed as

A company's budget serves as a guideline in planning and committing costs in order to meet tactical and strategic goals. Tactical goals such as providing budgetary costs for daily operations, and strategic objectives that include R&D, production, marketing, and distribution are all part of the budgeting process. Serving as a guideline rather than being set in stone, the budget is a snapshot of manager's "best thinking at the time it is prepared." (Marshall, 2003, p.496) The budget is a method in which to reign-in discretionary spending, and will likely show variances between what costs have been anticipated and what costs are actually incurred.

The PAYBACK technique is based on cash flows and it measures the time which is required for a proposal’s initial cash outflow to equal its cash inflow generated by the investment, the solution is expressed in years and month or days.

The use of an accounting rate of return also underscores a project 's true future profitability because returns are calculated from accounting statements that list items at book or historical values and are, thus, backward-looking. According to the ARR, cash flows are positive due to the way the return has been tabulated with regard to returns on funds employed. The Payback Period technique also reflects that the project is positive and that initial expenses will be retrieved in approximately 7 years. However, the Payback method treats all cash flows as if they are received in the same period, i.e. cash flows in period 2 are treated the same as cash flows received in period 8. Clearly, it ignores the time value of money and is not the best method employed. Conversely, the IRR and NPV methods reflect that The Super Project is unattractive. IRR calculated is less then the 10% cost of capital (tax tabulated was 48%). NPV calculations were also negative. We accept the NPV method as the optimal capital budgeting technique and use its outcome to provide the overall evidence for our final decision on The Super Project. In this case IRR provided the same rejection result; therefore, it too proved its usefulness. Despite that, IRR is not the most favorable method because it can provide false results in the case where multiple negative

Net Present Value and Internal Rate of Return can disagree when the initial investments are substantially different as well but in this case the initial investment was the same.

The discount rate is a means of calculating a value now of benefits that occur in the future. The discount rate recognizes the time value of money. A four percent real discount rate is used in the calculations. However, the high-speed train project would be economically feasible even under the higher discount rates used by some public agencies and economists. The Internal Rate of Return (IRR) is an evaluation measure that is

Internal rate of return (IRR) and Payback period “IRR of a project provides useful information regarding the sensitivity of the project’s NPV to errors in the estimate of its cost of capital” (Pierson et al.2011, pp.157).This proposal also shows the project is profitable by using Excel to get the IRR of 18.9%, which is

Capital budgeting is the most important management tool that enables managers of the organization to select the investment option that yields comprehensive cash flows and rate of return. For managers availability of capital whether in form of debt or equity is very limited and thus it become imperative for them to invest their limited and most important resource in perfect option that could prove to beneficial for the organization in the long run (Hickman et al, 2013). However, while using capital budgeting tool managers must understand its quantitative and qualitative considerations that are discussed below.

The internal rate of return (IRR) and the net present value (NPV) techniques are 2 investment decision tools that satisfy the 2 major criteria for the correct evaluation of capital projects. This criterion is that the techniques should incorporate the use of cash flows and the use of the time value of money. This makes them viable techniques for evaluating investment proposals.

Project appraisal techniques are used to evaluate possible investment opportunities and to determine which of these opportunities will generate the best return to the firm’s shareholders. Therefore, it is vital for the firm if they wish to continue receiving funds from shareholders to employ the best techniques available when analysing which investment opportunities will give the best return. There are two types of project appraisal techniques: non-discounted cash flows and discounted cash flows. The Net Present Value and internal rate of return, examples of discounted cash flows, are in use in many large corporations and regarded as more effective than the traditional techniques of payback and accounting rate of return. In this paper, I