Quiz 16: Capital Expenditure Decisions

Business

Time is Money: Capital Budgeting is vital to take marketing decisions. The investment decisions take time to be relied on the returns got on investment. It is incautious to make the investments that are nonpaying with long run, except project is about only the social reasons. It could be worthy to apprehend the current value as well as returns of future investment. Sometimes, it could be more worthwhile placing prearranged investment money into the bank and earn interest, or make investment in the alternative projects. Distinctive investment decisions incorporate decision to build another grain silo, cotton gin, cold storage or spend in new distribution siding. Having lower level, the marketers may want to evaluate whether to apply extra on advertising or increase the sales force. Capital Budgeting V/s Current Expenditures The project of capital investment can be separated from existing expenditures using two features: a) Those projects that are reasonably large b) A substantial time period (more than one year) passes between the investment outlay and reception of profits. As an outcome, most medium-sized and bigger organizations have recognized special procedures and techniques to deal with decisions. Any systematic method of capital budgeting denotes: a) Preparation of long-term objectives b) Creative search and identification for new investment prospects c) Project classification and recognition for economically as well as statistically reliant proposals d) Estimation and prediction of the current as well as future cash flows e) An appropriate administrative framework, up to transferring necessary information to decision level f) The governing of the expenditures as well as careful observation of the decisive aspects of the project execution g) Set of judgment rules that can differentiate, suitable from the unacceptable options is necessary. Therefore in taking capital budgeting decisions, the concept of current value becomes really significant. Present Value It is value of today for payment or the payments need to be recognized in future. This is the value today for future payments or payments series, reduced at appropriate discount rate. Factors Regulating the Present Value 1. Amount of payment/payments 2. When the payment(s) is to be made in the future 3. The earning influence of money over the future period in the meantime the appropriate interest rate to use the discounted future dollar amounts.

Distinction between the following two types of capital-budgeting decisions: Acceptance or Rejection Decisions and capital-Rationing Decision img

Lower the Discount, Greater is the Present Value of Future Cash Flow: The value of future money can be calculated to present worth or present value with the "discount rate" as img Where: F = future cash flow (positive for receipts, negative for disbursements) PV = present value i = discount rate n = number of interest periods The factor img is known as the "single payment present worth factor". Discount Rate The interest rate utilized in the discounted cash flow analysis for determining the existing value of the future cash flows. The discount rate takes into account time value of the money (the idea is that money accessible now is worth more than same amount of money obtainable in future as it might be earning interest) and risk or uncertainty for anticipated future cash flows (that might be less than anticipated). Apart from other uses, discount rates are used for calculating value of the future income streams to present day. The discount rate will differ in the lost profit analysis, where income stream can be less assured, depending on the degree of risk related with the income stream. For determining the correctness of statement as well as measure dependency of the discount rates as well as present value let's assume as per the above formulae the following discount rates: Future Income stream of $100,000 and discount rates = 4 %, 8 % and 12 % respectively Discount Rate Present Value Estimate 4% ……………………………………… $811,090 8% ……………………………………… $671,008 12% …………………………………….. $565,022 Therefore the lower the discount rate the higher is the present value of future cash flows.