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This is a discussion question - Essay Example

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Before setting up a business or signing a contract, a calculated capital budgeting is required to decide which project is suitable or can secure their investments from a total loss or slow recovery. In this process we need to calculate three things which gives a very clear idea…

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CAPITAL BUDGET PROCESS Before setting up a business or signing a contract, a calculated capital budgeting is required to decide which project is suitable or can secure their investments from a total loss or slow recovery. In this process we need to calculate three things which gives a very clear idea to analyze that which deal is profitable. These three values are payback period, Internal rate of return and Net present value. From these three, net present value matters the most.
Similarly, from the given details of project A and project B, though the payback period of Project A is much higher which is 1.89 years than Project B which is 3.75 years but an investor would give least attention to this and would consider Net present value and will go for Project B which is \$114.409 which in comparison to Project A ( \$56.922 ) is much higher than Project A.
If an investor is keen to go through the details except than just considering payback period so investor will look at the internal rate of return of both the project to decide further which should be greater than given interest rate. In this case, internal rate of return of both projects is greater than the given interest rate of 12%. Considering specifically, Project A have a higher percentage which is 26.72%, whereas Project Bs is 19.74%. But investor would again justify Project B because it is widely known in business market that big investment at low percentage has a higher turnover than a small investment at 100% profit return for example \$1 at 100% profit will return \$2, whereas \$100,000 at 80% will return \$180,000. This shows that low rate of return is better on huge investment which is again justifying project B with an investment of \$400,000.
Thus if both projects are independent, investors can go for both but if they are interlinked than Project B is a justifiable deal in terms of profit. Read More
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