Disadvantages Of Capital Budgeting

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A firm cannot operate unless it has a strategic plan. Management is put in place to make decision for these plans to make a firm successful. Important decision by management is considered capital budgeting. This is how a company knows if an investment is worth it. Capital budgeting helps a company to strategize for the next few years (Parrino, Kidwell, & Bates, 2011).
Capital budgeting projects can be classified into three types: (1) independent projects, (2) mutually exclusive projects, and (3) contingent projects. Capital budgeting have two terms cost of capital and capital rationing (Parrino, Kidwell, & Bates, 2011, pp. 304-305). Parrino, Kidwell, & Bates (2011) further noted that cost of capital can also be thought of as opportunity cost
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This is because it allows managers to adjust the discount rate of intermediate term cash flow to better match a realistic return for the cash flow.
It is possible modified internal rate of return will gain acceptance in the delayed manner that net present value gained acceptance over a period of several decades. If this is to be the case, we may see a surge in modified rate of return applications over the next decade as more financial managers work with this technique especially if the reinvestment rate argument is valid. (Ryan & Ryan, 2002, p. 361)
According to Chen, (2012) analyzing corporate finance practices in Europe sampling companies from UK, Netherlands, Germany, and France using capital budgeting techniques, cost of capital estimates, capital structure, and corporate governance. The results of this sample showed that most European companies choose payback period as their most popular capital budgeting method, followed by net present value and internal rate of return. They also did a survey of 214 Canadian CFOs on the capital budgeting methods used in their firms. Their result also showed that net present value, internal rate of return, and payback method as their popular methods. The results shows that 49.2%, 45.8%, and 38.8% of respondents always use net present value, internal rate of return, and payback

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