Question

give some thought to how you might use the capital budgeting techniques in order to rank projects. These are important measures used in the capital budgeting process.

Answer 1

Capital budgeting is the method of analyzing and selecting long term investments which are in line with the goal of companies wealth maximization.

The capital budgeting decisions are important, vital and significant business
decisions because
1.substantial expenditure involved.  
2. long period for the project.  
3. irreversibility of decisions.
4. The complexity involved in decision making.

Some common measures or techniques used in the capital budgeting process are:

1. Internal rate of return (IRR)

IRR: It is the discount rate at which the present value of projects cash outflows (cost) is equal to the present value of projects cash inflow.

The IRR must be above the cost of capital/required rate of return.

To accept the project. The project with the highest internal rate of return given the first priority.

2. Net present value.
NPV = present value of cash inflow- the present value of cash outflow.

Discounted at the cost of capital/required rate of return.

NPV must be positive to accept the project.

The project with the highest net present value is given the first priority in the ranking.

3. Payback period: it is the amount of time required to recover the original cost of the project.

The project with the lowest payback period is given the first priority.

4. Profitability index= present value of cash inflow/ present value of cash outflow.

The project with the highest profitability index is given the first period in a ranking.