Capital Budgeting Decision
Table of Contents
Capital Budgeting Decision will be taken to identify whether accept or reject the project. There are three different projects in which one project will be selected and the reasons will be identified behind that whether the project is selected or rejected. Different businesses use different methods to determine whether the project is accepted or rejected. In most cases, the Net Present Value method is used, and it has been determined that if the NPV is positive then the project will be accepted and if the NPV is less than zero or it is negative then the project must be rejected (Balarabe, 2020).
Three Different Cases
Proposals that have the yield of return greater than the required rate of return or the cost of capital then it should be accepted, and the rest all the projects must be rejected, and all the independent projects must be accepted.
- The First project is Micron Inc.’s Cost of capital is 6.4%, NPV (Net Present Value) is equal to zero, and the required rate of return is 9.1%. When the NPV (Net Present Value) is equal to zero, the project may accept or rejected.
Also, the Cost of Capital = Internal Rate of Return, and the Required Rate of Return = Hurdle Rate.
IRR (Internal Rate of Return) = Cost of Capital = 6.4%
Hurdle rate = Required rate of return = 9.1%
6.4% < 9.1%, therefore the IRR (Internal Rate of Return)< Hurdle Rate.
If the IRR (Internal Rate of Return) is less than the hurdle rate, then the project will be rejected(Bora, 2015).
- Second project is Gramercy Inc. Internal Rate of Return = 10.8%, Initial Investment = $90,000 and hurdle rate = 10.2%
IRR (Internal Rate of Return) = 10.8%
Hurdle Rate = 10.2%
10.8% > 10.2%
IRR (Internal Rate of Return) > Hurdle Rate
Therefore, the IRR(Internal Rate of Return) is more than the Hurdle Rate and the project will be accepted.
- In the third case, Dinamo Inc. has NPV (Net Present Value) is ($5000). The Hurdle Rate is 8%.
Also, when the NPV(Net Present Value) is negative or NPV(Net Present Value) is less than zero, it means the project must be rejected. Therefore, the third project will be rejected (Bora, 2015).
Out of all three cases, the second project will be accepted.
Capital Budgeting is an important tool because it will evaluate the decision and measure the project value throughout its life cycle. The ranking of the projects will be done by taking the capital budgeting decision, and capital budgeting is used for the decision-making purpose of the long-term investment. Capital budgeting decision determines the ranking of the project and the company will use capital budgeting to determine whether the business should take this project or not(Balarabe, 2020).
Therefore, out of all the three projects, 2nd project of Gramercy Inc. in which there is an initial investment of $90,000 and the internal rate of return is 10.8% and the hurdle rate is 10.2% will be accepted because the internal rate of return is higher in this case.
Balarabe, B. (2020). Capital Budgeting Decision and Its Implication ToFirm’S Growth in Nigeria. International Journal of Advanced Academic Research, 6(4), 100-106.https://www.ijaar.org/articles/v6n4/sms/ijaar-sms-v6n4-apr20-p15.pdf
Bora, B. (2015). Comparison between net present value and internal rate of return. International Journal of Research in Finance and Marketing, 5(12), 61-71.https://d1wqtxts1xzle7.cloudfront.net/41051869/comparison_between_NPV_and_IRR-with-cover-page-v2.pdf?Expires=1650701980&Signature=XccrCfgwdXx~tmXfHsS308MgTQdaVas9rH4XnyEQcB8r9BmHUChX1Qy1h17-Fi7nZEscaV58GmHWGMODWOfFAX-2CSrJPT0cJWR8CsKvBHIQukTqbdsqjB~EbKMSjiXU6S7g1JbwYAuqJ7ORI5Hpo53PHVzfrHTpqX94PICm-7wJ1MfgWObtdrB9BQtfi9MGeroDzAqbNb9cBTPvLF8nF~iYbMYho28ShkaUlRJ1743tU-t9kfLyGoTsHhj36vLrwVfqrsZUGsN6F1QzCJgluX-JlwB4-darHTbjhuYq2DkV4cEqVbTbKU3n~3dYeVkZPwxQKzi2bjDcl8HMBbDsmg__&Key-Pair-Id=APKAJLOHF5GGSLRBV4ZA