How to Use capital Budgeting Tools to analyze project?


The concept of capital budgeting is that it must be done by taking into account all the cash inflows and outflows so as to calculate net ash flow. This net cash flow is then analyzed using proper capital budgeting tools for applicable periods. The details of tools that can be used in doing this type of analysis are as follows:-

Net Present Value (NPV)  

NPV:  It is basically calculated as difference between the present value of the total cash outflow made in the project and the total cash inflow made. The general rule to accept any proposal is to have positive NPV and vice versa as per our best capital budgeting assignment help experts. The formula to calculate NPV is given below:-

 Net present value =   Cash Flow1/(1+r)^n+…..+Cash flow N/(1+r)^n- C0

Where C ash flow (1..n) = cash flow at different time interval

            Co = initial investment

             r = Cost of Capital

             n= various time interval          

In this case NPV project in the following way:-

·         The cash flow for various costing method is determined first using different options.
·         NPV is calculated using cost of capital given
·         The best option is selected i.e. one having highest positive NPV.
The various advantages and disadvantages to use NPV are as follows:-
Advantages
·         It considers the time value of money in its evaluation.
·         It gives equal importance to both cash inflow and outflow
·         It gives higher importance to profitability and risks
·         Easy to implement and calculate
·         Firm can maximize its return using this option
Disadvantages
It is quite difficult to apply in various analyses where cash flow is not proper
·         The NPV cannot be used for comparison for two different projects with different life
·         It is complex to implement when WACC is used as discounting factor

 IRR

IRR stands for internal rate of return. It basically gives the rate at which project will give the return to the shareholders or various stakeholders as per our corporate finance assignment help service experts. The general principle to use these tools is as follows:-

·         Accept the project if IRR is greater than discounting factor
·         Reject the project if IRR is lesser than discounting factor

In this project, two cash flows at different interval will be analyzed using this tool so as to calculate which gives higher IRR.
Pros of IRR

·         It considers the time value of money in its evaluation.
·         It gives equal importance to both cash inflow and outflow
·         It gives higher importance to profitability and risks
·         No need for WACC calculation
·         Firm can maximize its return using this option

Cons of IRR

·         Very complex to understand and calculate manually

·         Some of the assumptions sued by it are not realistic


·         3. It is not useful at all to compare two mutually exclusive project

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