CAPITAL BUDGETING - Capital Budgetin g November 1 2007...

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Capital  Budgeting November 1 2007 This report analyzes two potential investment projects, Sam’s  Capital Budgeting methods have been applied to assess their  economic viability. Mohamed  Nabeel  Hassanali
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TABLE OF CONTENTS PAGE Title – Cover Page 1 Table of Contents 2 Abstract 3 1.0 Definition - Capital Budgeting 3 2.0 Independent and Mutually Exclusive Projects 4 3.0 Payback Period 5 4.0 Payback Method Rationale 7 5.0 Regular and Discounted Payback Periods 7 6.0 Disadvantage of Discounted Payback 11 7.0 Net Present Value (NPV) 11 8.0 NPV Rationale 13 9.0 Internal Rate of Return (IRR) 14 10.0 IRR Rationale 15 11.0 Recommendation 15 12.0 Conclusion 16 13.0 References 17 2
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ABSTRACT A sum of $300,000 has been accorded which will act as capital. This amount will be invested in Franchise S – Sam’s Wonderful Fried Chicken; or, Franchise L – Lisa’s Soups, Salads and Stuff. If profitable, both ventures may be undertaken. Before embarking on either project, an extensive investigation would be carried out to assess the returns and financial viability of both projects. The payback periods, Net Present Value (NPV), and Internal Rate of Return (IRR) are to be analyzed based on which investment decisions can be made. 1.0 DEFINITION – CAPITAL BUDGETING Capital budgeting (or investment appraisal) is the planning process used to determine a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research and development projects. An investment is worth undertaking if it creates value for its owners. In most general sense, companies create value by identifying an investment that is worth more in the marketplace than the cost of acquiring it. Capital budgeting is also a fundamental process that helps in determining profitability of a capital investment. Firms increasingly have difficulties in raising finances for their investments. As such, simultaneous investments have become a rarity. Thus, capital budgeting assists financial managers in comparing the viability of different investment projects that helps to select the most profitable venture. Many formal methods are used in capital budgeting, including the techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), and Payback period. 3
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2.0 INDEPENDENT AND MUTUALLY EXCLUSIVE PROJECTS A project whose acceptance or rejection is independent of the acceptance or rejection of other projects is an Independent Project. In other words, these initiatives can be undertaken simultaneously as both fall within or on the boundaries of financial affordability. However, mutually exclusive projects are such that if one is chosen the other one cannot be undertaken. Due to financial constraints, financial managers may not be able to advice firms on concurrent investments. Therefore, firms may have to choose either of the projects depending on the extent of returns on investment. If two investment projects A and B are said to be mutually exclusive, taking on one
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This note was uploaded on 04/09/2009 for the course MISC Misc taught by Professor Misc during the Spring '07 term at SUNY Plattsburgh.

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CAPITAL BUDGETING - Capital Budgetin g November 1 2007...

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