Question

The topic is: Capital Budgeting

1. identification: Identify the topic and explain why you believe the topic is important.
2. Explanation: Explain the calculations or concepts, and how it can be used in decision-making.
3. Application: Assuming your audience knows nothing about the topic, explain how to apply it:
   1. As an entry-level professional.
   2. As a mid-level professional.
   3. As an executive-level professional.
4. Ethics: Identify 1 ethical issue related to this topic and explain how you would address it.

Answer 1

Capital budgeting, in plain words, is the process of evaluating investments and large expenses. A company regularly makes investments in different projects in order to further its operations and business. It entails feasibility analysis of major projects or investments. For example a company may evaluate different options to invest in new plants or equipment. This topic is important as it will help a company and its stakeholders to ensure that expected returns from an investment in a project exceeds a benchmark rate.

The calculations and concepts of capital budgeting are popular metrics like payback period, net present value, discounted payback etc. Payback period is the length of time that is required to recover the initial cash investment on a project. For example a project requires initial outlay of $60,000 and inflows in next 4 years are - $10,000, $15,000, $35,000 and $20,000. We can see that initial investment of $60,000 is recouped at the end of the 3^rd year (10000+15000+35000 = 60,000) and so payback is 3 years. Net present value is the sum of all present values of cash flows associated with a project. So NPV = sum of all cash flows in future periods/(1+r)^t – Initial investment. Here r is the discount rate and t is the year of cash flow. Discounted payback is similar to payback, the only difference is that in case of discounted payback time value of money is considered.

Applying capital budgeting as an entry-level professional – An entry level professional can do theoretical and numerical computations and determine feasibility of different investment options. For example if there are three projects A,B and C and the company needs to determine the best project then the entry level professional can use tools of net present value or discounted payback etc. to determine the best project.

Applying capital budgeting as a mid-level professional will entail making recommendations on the basis of analysis done by entry level professionals. The mid-level professional can do scenario analysis and create a what if analysis i.e. what will happen to capital budgeting decisions if economy contracts by 5% or if a new competitive product is launched etc.

Applying capital budgeting as an executive-level professional will entail in-depth decision making and then making the actual investments so that maximum value is generated for the stakeholders.

One ethical issue related to capital budgeting is that only profitability is considered and ethical and moral factors involved in a project or in an investment like lawsuits or public backlash are ignored. For instance a project might give the highest rate of return but will also cause high degree of pollution and environmental damage. This is an ethical issue. To address this ethical and qualitative factors have to be incorporated into decision making and it should be ensured that decisions are not taken solely on the basis of a project’s ability to generate profits.