Question

Please list and fully describe three different real options a firm may want to consider when evaluating projects in the capital budgeting process..

Answer 1

Whlie evaluating projects under capital budgeting, a firm maywant to consider NPV, Pay back Period and IRR.

1. NPV - NPV or Net present value of the project means the difference between the present value of cash inflows and present value of cash outflows. This reflect whether the project is profitable after discounting the cashflows with the cost of capital.

2. Pay back Period- A company will not want to engage its capital in a single project for very long. Hence they will consider payback period while evaluating projects. The pay back period represents the time period in which the company will recover its initial cash outlay.

3. IRR - Internal rate of return reflect the maximum cost of capital a company can afford for a project. If the cost of capital is more than IRR, then the project is not profitable.hence company's also consider IRR during the project evaluation.