Advantage Of Capital Budgeting
The need for relevant information and analysis of capital budgeting alternatives has inspired the evolution of a series of models to assist firms in making the "best" allocation of resources. Capital budgeting is determining how much “the firm pay to finance its operations using debt and equity sources?” (Coo, 2024, p. 373). It helps the company decide which projects will be profitable and when a return can be expected.
Adjusted Present Value (APV) and Net Present Value (NPV)
Net Present Value (NPV) is a common technique used in capital budgeting decisions. NPV measures how profitable is a proposed project. APV is NPV adjusted for the “interest and tax advantages of leveraging debt if equity is the only source of financing” …show more content…
The profitability index is an index that attempts to identify the relationship between the costs and benefits of a proposed project. This is done by dividing the present value of future cash flows to the project by the initial investment. A Profitability Index ratio of 1.0 or greater makes the proposed project attractive financially; less than 1.0 means that the project will lose money. The advantages of the Profitability Index are that the method considers the time value of money and ascertains the exact rate of return of the project. Negatively, the Index is not useful if the determination of profitability is between projects that have different life spans (Accounting Management, …show more content…
Also, to get the best return the timing of the cash flows is vital as the cost of capital has a direct relationship to the interest rate at that time. (Cooper, Morgan, Redman, & Smith, 2002, p. 15). Techniques such as IRR and Profitability Index are both primary budgeting models. IRR is the most popular rate-based capital budgeting technique (Cornett, Adair, & Nofsinger, 2015, p. 449).
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Cooper, W. D., Morgan, R. G., Redman, A., & Smith, M. (2002). Capital budgeting models: Theory vs. practice. Business Forum, 26(1), 15-15+. Retrieved from