Capital Budgeting

Capital Budget Recommendation

University of Phoenix

Managerial Accounting & Legal Aspects of Business

AC543

Sean DAmico

August 20, 2012

Abstract

This paper will compare and contrast the relationship between the various capital budgeting evaluation techniques in the corporate business setting. There will be a recommendation given for the Guillermo Furniture Company based on the results of one or more evaluation techniques, which in turn will help direct the overall financial health of the organization.

Corporations are continually striving to improve the overall financial health of its organization and one strategic way many corporations are doing that is through capital budgeting. Capital budgeting involves choices. The choices revolve around projects that will add value to the organization. The projects can include and are not limited to acquiring land, purchasing a truck, or replacing old equipment. Many times, corporations are strongly encouraged to undertake projects that will increase its profitability. The challenge is to find the appropriate evaluation method to bring the intended profitability into reality.

The three preferred evaluation methods that are used by corporations are net present value, internal rate of return, and payback period. Many corporations often calculate capital budgeting solutions using all three methods. However, each method often produces contradictory results. The net present value method is the most accurate valuation approach to capital budgeting issues. If a corporation can discount the after tax cash flow by the weighted average cost of capital, managers can determine if the project will be profitable or not. The net present value method reveals exactly how profitable a project will be to the corporation versus the alternative methods. With the various evaluation methods, corporations are able to base the decisions for the future on the results of the evaluation. The net present value method...