Imagine you are a representative of management in the company you have selected
ID: 2765362 • Letter: I
Question
Imagine you are a representative of management in the company you have selected for your Week Six assignment and you must make a capital budgeting decision. The decision is to implement a new computer network system to decrease the time between customer order and delivery. The cost will be 10% of last year’s profits. You are charged with describing the important considerations in the decision-making process to upper management. In your response, be sure to include the following:
A description of the important factors, in addition to quantitative factors, that were considered when making this capital budgeting decision.
An explanation of how these factors are significant to the company.
A summary of how you will determine the criteria to rank capital budgeting decisions and whether some criteria are more important than others.
A calculation of the proposed return on investment based on criteria you select and justification for that ROI.
Develop a 200 – 250 word explanation supporting your recommendations.
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Explanation / Answer
Important factors :
Explanation of how these factors are significant to the company
Criteria of ranking for capital budgeting decision should be based on NPV, It is through NPV, we can get the present value of entire cash flow generated in future and thus deducting it with present value of investment. This should be preferred over others ranking methods like IRR and payback because it has the applicability of inclusion of depreciation (A non cash item) and taxation (Which is a measure expense).
NPV should always be preferred because this investment is going to increase the cash inflow of the firm and that cash inflow must be compared with cash outflow at present time. Hence, It becomes paramount to use this technique while selecting the capital budgeting decision.
Calculation of return on investment:
Hypothatical example:
Suppose the initial investment is USD 100,000 and the present value of incremental cash inflow over next 15 years is USD 200,000. Hence, the NPV will be USD 200,000- USD 100,000= USD100,000, ROI will be 100%.
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