Question

If you want to compare projects, what process in steps would you follow to do your capital budgeting?

Answer 1

Firstly the different projects need to be identified. It is required to be ascertained if the projects are mutually exclusive or can be conducted simultaneously.

The initial cost of the projects has to be estimated and there after the future cash flows have to be estimated. The weighted average cost of capital of the company is used as the discount rate for determining the present value of future cash flows. The comparison process requires the determination of net present value of these projects to determine which project adds the greatest value to the business.

There are various considerations involved such as tax factors, depreciation rules and estimation of the discount rate including adjustment for Risk. Also impact of the project on the existing revenues of the business should be taken into account. The project with the highest net present value should be taken.