logo image

Capital project Essay

In capital budgeting decisions there are certain variables present in the business industry that ought to be taken into account to ensure that the appropriate figures are utilized in the capital expenditure appraisal. In capital budgeting, the principle of the time value of money arises, which basically states that $1 today is much more worth than $1 next year. This is due to four key components, which are: inflation rate, the risk-free component, general risk premium and property-specific risk premium.

The general rise in prices occurring is an economy is an important component of the discount rate. The inflation is usually determined by measuring the Consumer Price Index, which is quarterly calculated by the United States Bureau of Labor Statistics. This comprises the first element, which comprises the discount rate as stated in the previous paragraph. There are a number of methods that can be adopted in determining the discount factor. One of them is the weighted average cost of capital that was used in the previous part.

There are also the capital asset pricing model and the dividend growth model that can be used for such facet. All the methods hold their advantages and disadvantages. Thus it is up to management

Need essay sample on "Capital project"? We will write a custom essay sample specifically for you for only $ 13.90/page

good judgment on which is the best method to use. This is due to the fact that sometimes one method is more applicable and better than other technique depending on the situation at hand. Inflation is not only a key determinant of the time value of money principle. It is also a key player in the computation of the cost of capital determined for the capital project.

Sometimes during the determination of cash inflows and outflows stemming from the capital project, management erroneously does not consider inflation in such calculations. The absence of inflation leads the real cash flows to be equal to the actual money changing hands. However, when inflation is taken into account, which ought to be since it a real factor continuously present in the business environment, the two variables mentioned above does not equal each other. In such instances a real discount factor rate is determined, which considers the inflation element.

The equation utilized in this respect is the following: In today’s business environment, predictions are increasingly unsure due to the fast changing variables in such environment. Therefore, the uncertainties of cash flows are always present irrelevant of which forecasting technique is used. An effective method that can be used in order to mitigate such uncertainty issue is a sensitivity analysis. This basically encompasses variation of the key factor values, which mainly consist of the cash inflows and outflows in order to portray a wider spectrum of the capital project’s effect.

The adoption of such method will therefore provide further financial information to management in order to aid them in their decision. Again judgment and attitude towards risk plays a critical part in such facet.

References: Brockington B. R. (1993). Financial Management. Sixth Edition. London: DP Publications. Drury C. (1996). Management and Cost Accounting. Fourth Edition. London: International Thomson Business Press. Lucey T. (1996). Quantitative Techniques. Fifth Edition. London: Ashford Colour Press.

Can’t wait to take that assignment burden offyour shoulders?

Let us know what it is and we will show you how it can be done!
×
Sorry, but copying text is forbidden on this website. If you need this or any other sample, please register

Already on Businessays? Login here

No, thanks. I prefer suffering on my own
Sorry, but copying text is forbidden on this website. If you need this or any other sample register now and get a free access to all papers, carefully proofread and edited by our experts.
Sign in / Sign up
No, thanks. I prefer suffering on my own
Not quite the topic you need?
We would be happy to write it
Join and witness the magic
Service Open At All Times
|
Complete Buyer Protection
|
Plagiarism-Free Writing

Emily from Businessays

Hi there, would you like to get such a paper? How about receiving a customized one? Check it out https://goo.gl/chNgQy

We use cookies to give you the best experience possible. By continuing we’ll assume you’re on board with our cookie policy