Your Mark
Capital Budgeting Decision of Your Mark
Abstract
The purpose is to evaluate the capital budget decision by Your Mark. Various valuation techniques such as payback, NPV, IRR and MIRR have been discussed, with their pros and corns. It has been also discussed whether the project is acceptable under each project or not.
Capital Budgeting Decision
Capital budgeting decision is critical for a company. It may include purchase of fixed assets, construction of building, factory, etc. One good decision may groom the company and one bad may broom the company. It is difficult to reverse the capital budgeting decision, once it is taken; therefore, it is necessary that one should be careful when deciding about the capital budgeting decision. Therefore it is necessary that proper evaluation of investment should be made and it can be done by various methods such as payback period, net present value, internal rate of return and modified internal rate of return method.
As the Your Mark Company has to make investment of around $1.3 million, therefore it is necessary that it should be evaluated by using all of above method. The result of above investment is as follows:
Year / Cash flow / D.F 14% / PV0 / -1300000 / 1 / -1300000
1 / 500000 / 0.8772 / 438596
2 / 350000 / 0.7695 / 269314
3 / 475000 / 0.6750 / 320611
4 / 450000 / 0.5921 / 266436
5 / 300000 / 0.5194 / 155811
NPV / 150768
Payback Period / 2.95 / years
IRR / 19%
MIRR / 17%
The payback period shows how quickly the invested amounted is paid back. The company target for this evaluation method is 5 years, but the project is well ahead of this target and recovering all its investment in around 3 years. According to this method the project should be accepted. But the final decision may not be taken by this method as it ignores the time value of money and also does not consider the cash flow of project after payback period.
When the difference between present value of future cash inflows after taxes and cash outflows after taxes is calculated it is called net present value. It helps in knowing what is the worth of project considering the time value of money and cash flows after taxes. The investment by the company is showing a positive net present value of $150768. The method considers both time value of money and also the cash flow of the whole life of the project. The method is used for mutually exclusive projects, but as company does not have any other option of investment therefore the decision may be made on the basis of net present value of the project. And as the NPV is positive therefore it should be accepted.
Internal rate of return is nothing but a discount rate at which the net present value is equal to zero. If the internal rate of return is higher than the required rate of return the project should be selected otherwise not. If decision is to be made between two projects, the project with higher IRR should be selected. As the investment is showing an internal rate of return of around 19%.which is far better than 14%, which shows that the investment is good one and should be accepted.
The difference between modified internal rate of return and internal rate of return is only in the rate of reinvestment. In IRR, it is assumed that the cash flows are reinvested at the rate of IRR, but in MIRR, it is assumed that cash flows are reinvested at the rate of cost of capital, and most of the time the MIRR is less than IRR. The investment is also showing a MIRR of 17% which is again better than cost of capital, which is also a sign of project acceptance.
Conclusion
It is quite apparent from above analysis that the project should be accepted as each method is showing favorable results.
References