Discussion Response 3.1

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Capital Budgeting Methods

Response Guidelines

Respond to at least two peers (see below). Your responses should be substantive and could involve one or more of the following:

o Debate the topic. o Ask a probing question. o Share an insight you gained from your peer's post. o Make a suggestion. o Share a personal experience related to the topic. o Expand on your peer's post.

The replies should be at least 50 words minimum

Student 1

Net present value refers to difference between the present value pertaining to the cash inflow and the present value pertaining to the cash outflow. The net present value is generally used for analyzing the profitability pertaining to the project or projected investment underlying capital budgeting.

Internal rate of return basically refers to the discount rate being used in the capital budgeting which turns the net present value pertaining to all cash flows equal to zero for a particular project. Therefore higher is the internal rate of return of the project more viable it becomes for undertaking a particular project. Since rate of return of an investment is represented by IRR. Thus IRR means a point where present value of inflow is equal to outflow. If company’s cost of capital is less than IRR that project will be profitable for the company and that project can be accepted.

Student 2

Capital budgeting is used to help make decisions on whether to accept or decline a project. The three main types of capital budgeting methods are NPV, payback period method, and the internal rate of return. The NPV method is the net present value. With this method you would accept a project if the NPV is greater than zero and reject if less than zero. NPV uses all the cash flows of the project, and this is a main key to the NPV method (Ross, Westerfield, Jaffe, & Jordan, 2018).

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The payback period method informs you when the cash outflow is paid back by the cash inflow. With this method there is a cutoff date, and any project that lasts longer than that date is rejected. There are issues with this method due to timing of cash flows within the payback period, payments after the payback period, and arbitrary standard for payback period (Ross, Westerfield, Jaffe & Jordan, 2018).

The IRR is very similar to NPV. This method has a single number summarizing the merits of a project (Ross, Westerfield, Jaffe & Jordan, 2018). If the discount rate of the project is below 10 percent, the company should accept it. If the IRR is greater than the discount rate the project should be rejected.

If I were a financial manager I would use the NPV since it seems to be the best out of the three. I do find that the IRR would be easier to understand since it uses percentages and would also consider it.

Reference:

Ross, S.A., Westerfield, R.W., Jaffe, J.F., and Jordan, B.D.(2018). Corporate Finance: Core Principles and Applications. (5thed.). New York, McGraw-Hill.