Question

This will focus on analyzing and evaluating a time value of money capital budgeting scenario.

Describe, and explain how the following computations pertain to the company’s profitability, and how the required rate of return (discount rate)and these computations impact the projector projects’ approval:

5. Break-Even Time (BET)

Answer 1

5. Break-Even Time (BET)

Break even time is the time period taken by the cash flows to recover the initial investment of the project. The lower the break even time it is good for the firm since the initial investment will be recovered faster. At Break-even time the initial investment is equal to the cash flows generated by the project. The cash flows considered in break-even time can be discounted or non discounted cash flows. Discounted cash flows are usually preferred since it considers time value of money. The cash flows are discounted to present value based on the cost of capital of the firm. The higher the discounting rate the lower is the present value of cash flows generated by the project.

Lower break even time indicates the projects are having less risk and can be implemented if their net present value if positive. A firm should try to increase the cash flows of new project to ensure the capital budgeting is effective and it adds value to the firm.