Capital Budgeting Decisions

Capital Budgeting Decisions

Patricia Hill

Professor Victor Hugo Villarreal

Essentials of Business Development II

November 3, 2010

Abstract

My finalized company idea is a photography business called Rooh Photography, a small business providing photography services to tweens, teens, families and their pets. Since this will be started with little to no funding, it will be imperative to evaluate all capital funding methods carefully and select a method(s) to determine positive cash flow and rate of return.

Discussion

I believe the most appropriate approach for my business is the payback period methodology and net present value (NPV). The payback period methodology involves evaluating how long it takes before its costs are fully recovered, basically when the net positive cash flow will be coming back into the business. Since initial investment will be slim to none, this will be imperative. This method’s primary shortcoming is that it ignores the time value of money. This can be overcome if discounted cash flows are used to calculate the payback period.

After determining the return as well as the time period, I would then evaluate alternative investments to determine if there are ways to use this money to gain higher returns. Ideally, the method with the highest rate of return and the shortest payback period is preferred as a longer payback period increases the risk of unforeseen circumstances. The most commonly used methods are IRR and NPV.

The net present value of an investment tells you how this investment compares either with your alternative investment or with borrowing, whichever applies to you.  A positive net present value means this investment is better.  A negative net present value means your alternative investment, or not borrowing, is better. Since I am not an accountant, the formula is not that complicated and there are plenty of free calculators on the internet, NPV...