Decision-Making Process and Capital Budgeting Techniques (Research Proposal Sample)

Capital Budgeting - Assignment 4
Student’s Name
Institutional Affiliation
Part I
Capital budgeting involves the process of investment appraisal that includes the planning process that is used in the determination of whether a firm’s long-term investments such as purchase of new machinery and acquisition of suppliers are worth the funding by the firm. Since it involves the allocation of funds for major projects it should be aimed at increasing the firm’s value to its shareholders. It is worth the consideration of this planning process since it involves large amounts of money, which in turn has a great influence on the firm’s profitability (Bierman & Smidt, 2014). In addition, such projects are usually long-term and thus, once made they are irreversible without significant losses of the invested capital. Such an investment usually becomes sunk, and as such mistakes, as opposed to being corrected, must usually be borne until such a time when the firm involved can be withdrawn through such processes as liquidation or depreciation of charges. Owing to the significant impact of capital budgeting on the firm, in this case EEC, it is important to consider an enhanced analysis of the feasibility of acquiring the supplier.
Information Required
The process of analyzing the investment opportunity in the purchase of the supplier will be enhanced by the acquisition of a wide range of information that will enable the firm to make a viable decision on the capital project. Such information will include the cost of acquisition, which will be determined by carrying a valuation exercise on the firm to be acquired. It will be vital for EEC to determine the current value of the supplier so as to make a decision as to whether it should purchase the supplier in consideration of the firm’s financial capability (Bierman & Smidt, 2014).
In addition, the firm need to acquire information on its resource capability to carry out the capital project following the determination of the current market value of the supplier and other operation dynamics, the organization will need to determine if it is capable of financing and effectively operate the project both in the short and long terms. The firm needs to acquire information on the resources required to effectively run the supplier firm. Such resources may be in the form of finances, time, as well as human resources.
Capital projects have a great influence on the firm’s profitability as a result, it is important for the firm to have information on the returns of the project before making a decision on investing in it (Clayman, 2012). The firm should thus, collect information on the cost savings that will be achieved if it invests in the project.
So as to ensure that the firm does not risk its funds, it should take a step to acquire information on the prevailing market conditions, as well as competitive advantage levels to which the acquisition of the supplier will result in. Such will enable effective decision-making on the project since the decision makers will be able to get a glimpse of such factors as competition in the market and the manner in which the firm will be able to compete with other firms in the market.
Decision-Making Process and Capital Budgeting Techniques
The decision-making process in this case will involve a series of steps. Such will include gathering information on the project, especially in terms of the prevailing market conditions, current value of the supplier firm, as well as any future prospects on the project (Shim & Siegel, 2012). Following this process, it will be important to consider a number of other options including starting up a branch in EEC to cater for its supply solutions. The process will be effectuated by comparing the alternatives available and coming up with a final decision to purchase the supplier. It will also be important to consider the rate of return to assign the project so as to make it possible for the organization to plan for the investment effectively.
Different capital budgeting techniques maybe applied in making capital budgeting decisions (Bierman & Smidt, 2014). Such include the accounting rate of return (ARR) that is a ratio that gives the rate of return of a project that is generated from the project’s net income. It gives a ratio of the rate of return relative to the investment made and does not take into account the time value of money.
The payback period may also be used and refers to the period of time taken for the project to recover the amount invested. It thus, gives the measure of time taken for the project to pay the invested funds and does not take into account the time value of money.
The net present value (NPV) refers to the sum of the project’s present values of all the cash inflows and outflows over a specified period of time in the future. In this technique, time value of money is taken into account and provides that time has an impact on the value of the project’s cash flows (Osborne, 2013).
Net Present Value Calculation





 

 

 

 

Interest

14%


Year

Cash Flows


Year

Cash Flows

Present Value





0

($2,000,000)


0

($2,000,000)

-2000000





1

500000

($1,500,000)

1

500000

438596.49





2

500000

($1,000,000)

2

500000

384733.76





3

500000

($500,000)

3

500000

337485.76





4

500000

$0

4

500000

296040.14





5

500000


5

500000

259684.33





6

500000


6

500000

227793.27





7

500000


7

500000

199818.66





8

500000


8

500000

175279.53





9

500000


9

500000

153753.97





10

500000


10

500000

134871.90


















Net Present Value

($452,539.59)








Internal Rate of Return

10.18%














636,210










500000










136,210