Discussion Week7 - Discus the major capital budgeting...

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Discus the major capital budgeting methods used by corporations to evaluate projects. Why do many corporations continue to use the payback period method? Which method do you prefer? In major capital budgeting decisions, corporations use a number of methods to evaluate a project’s worth or value. Managers commonly use net present value, internal rate of return, modified internal rate of return, profitability index and pay back period to determine a project’s acceptability over another project. When a manager calculates net present value, he or she takes into account a project’s outflows such as the initial investment on a project and also includes the expected future cash inflows generated by that particular project. This is a vital tool used in the discount cash flow analysis, and is the method most commonly used in finance to appraise a long-term project. Managers use this method primarily because it is a guide to how significant a project would add to the value of a firm. For example, if the project has a positive NPV, this usually indicates that the project should be taken or executed because it would add value to the firm. Another very common alternative to appraising projects is the projects internal rate of return. While many managers use NPV, IRR is also used often to determine the profitability of a project. So the higher the internal rate of return the more suitable a project looks to a manager. Additionally, the reason why this method is called internal is that external factors are not considered in the calculation such inflation and interest rates. This can be considered a disadvantage with this method. The internal rate of return is also based on assumptions that a project’s positive inflows are reinvested, which causes this tool to overestimate returns. However, corporations usually use both (NPV and IRR) methods when deciding to fund a particular project because companies want to factor in the future cash flows and the required rate of return to break even in a project. The third method that is used by managers is modified rate of return. MIRR is similar to IRR in which it also assumes that a project’s positive

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