Guillermo Furniture-Capital Budget Recommendation

Differentiate among the various capital budget evaluation techniques.

“Several techniques for analyzing the cash flows associated with capital investments are

available. The techniques can be divided into two categories: techniques that use time

value of money concepts and techniques that ignore the time value of money. Generally,

techniques that ignore the time value of money are less accurate but simpler and easier to understand. These techniques include the payback method and the unadjusted rate of return

method. The techniques that use time value of money concepts are the net present value method

and the internal rate of return method. These methods offer significant improvements in accuracy but are more difficult to understand” (Edmonds, 2007, p. 1167-1168).

“The payback method is simple to apply and easy to understand. It shows how long it will take to recover the initial cash outflow (the cost) of an investment. Generally, investments with shorter payback periods are considered better. The payback method measures only investment recovery, not profitability. The formula for computing the payback period, measured in years, is as follows: Payback period = Net cost of investment/Annual net cash inflow” (Edmonds, 2007, p. 1164-1165).

“The unadjusted rate of return method is another common evaluation technique. Investment cash flows are not adjusted to reflect the time value of money. The unadjusted rate of return is sometimes called the simple rate of return. The accuracy of the unadjusted rate of return suffers from the failure to recognize the recovery of invested capital. With respect to a depreciable asset, the capital investment is normally recovered through revenue over the life of the asset. It is computed as follows: Unadjusted rate of return =Average incremental increase in annual net income/Net cost of original investment” (Edmonds, 2007, p. 1165-1166).

“The present value index method is used to compare different size investment...