Question

1A. Define capital budgeting and explain its significance B. Zelnic Corporation needs a food processing machine. It is considering two machines - Machine A and Machine B. Machine A costs $20,000 and will reduce operating cost by $5,000 per year. Machire B costs only $10,000 but will also reduce costs by $5.000 per year. Calculate the payback period and derr.or strate which machire should be purchased according to the payback method. Formula: Investnent required/Net annual cash inflow C.Explain the present value concept as a technique in capital budgeting. Using the present value approach, solve the following: Tom has $100 in a bank account that pays a guaranteed 5% interest rate each year. How much would Tom have at the end of Year 3?

Answer 1

1) Capital budgeting is the process of analyzing and ranking proposed projects that helps management to determine which ones are deserving of an investment. It consists of various techniques such as net present value, internal rate of return, payback period, profitability index and accounting rate of return.

Capital investments are huge however the funds are limited, thus a proper planning through capital expenditure is a pre-requisite for making decisions. Moreover, the capital investment decisions by the management are irreversible in nature; and capital budgeting gives a wide scope for management to evaluate various projects in terms of their viability to be taken up for investments. Thus helps in managerial accounting for exposing the risk and uncertainty of different projects; and keeping a check on under or over investments

　

2) Payback period of Machine A: Investnent required/Net annual cash inflow = 20,000 / 5,000 = 4 years

Payback period of Machine B: Investnent required/Net annual cash inflow = 10,000 / 5,000 = 2 years

According to payback method, machine B will be more desirable compared to Machine A because it has a shorter payback period