Capital budgeting is sought to enhance business profitability. A business normally deals with two kinds of expenditures – capital expenditures and revenue expenditures. Both are equally essential to run a business.
But, capital expenditures are particularly sought to enhance business profitability and shareholder value. It deals with investing in new or replacing plant and machinery, purchasing building for factory or business purpose, investing in long term ventures and worth pursuing research and development projects etc. Thus, capital budgeting have been widely acknowledged as the key to business growth and profitability enhancement (Investopedia, n.d).
How an organization would determine the total value to be allocated towards capital projects?
The most countable factor in allocating value to capital projects is owners will proper analysis and planning. From technical aspect there are number of methods to determine the total value to be allocated towards capital projects and some are internal rate of return, net present value, accounting rate of return, modified internal rate of return, equivalent annuity and profitability index.
Most commonly the internal rate of return and net present value are used to determine the value of capital projects. The internal rate of return investigates that how much the monetary gain will happen by pursuing a capital project. Similarly, the net present value investigates the futuristic gains of doing a project. Therefore, both methods determine the positive gain in growth and profitability of business.
Discuss the key factors that would determine if a project should be approved in a capital budgeting process
The only key factor in determining the project approval in a capital budgeting process is the business growth and profitability. Since the major purpose of capital budgeting is to enhance the shareholder’s value. Therefore, the project which decrease the running cost of business and increase the profitability should be approved in a capital budgeting process.
After a capital project has been approved and completed, discuss how you would assess whether or not the project had the desired financial return
The considerable part of assessing the capital project return is to assess the cash flow after completion of project. For instance, if a business invests in purchasing building for its official use will not pay rent anymore. It will eventually increase business’s fiscal profitability and correspondingly the shareholder value will increase as well. Moreover, if a business invests in merging another business for its expansion. After a certain period of capital recovery the new merged business will enhance profitability as well as shareholder value.
Hereinafter, an increase in cash flow and retained earning decides the approved and completed project’s financial returns. If there is positive change in cash flow and retained earning after completion of a capital project it means it has accomplished the project has accomplished the desired targets. Conversely, there is negative change in cash flow and retained earning then it means that the approved project does not achieved the desired financial returns.
At the end of essay it is better to restate the thesis of the essay that is capital budgeting is sought to enhance business profitability. In the essay it has been that planed and calculated capital budgeting will gives the positive results. Thus, the owners will and special concentration on the methods of capital budgeting can give the positive results. It is matter of fact that capital budgeting either gives fruit or flushes the finances. Hence, special understanding, analysis and application of right methods should be the part of the initial, in progress and completed capital projects.