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Capital Budgeting, Essay Example

Pages: 2

Words: 571

Essay

The steps of the marketing budgeting process that this paper finds to be most challenging is the forecasting future cash flow. This is because when an evaluation is carried out on a potential project, there must be adequate understanding and measurement of the various variables. Many of the revenues and costs are simply estimates. It is therefore extremely difficult to actually estimate the probability of success and consequently acceptance by the general public in the near future.

There are several pros and cons that are involved in applying different investment decision rules when faced with the choice of investing corporate funds. This paper will focus on the NPV method and the IRR method. The NPV method takes a great consideration on the time value of money and is therefore referred to as the sophisticated budgeting technique. As a result, calculation is done on the basis of the current dollars. For instance, incase $300,000 is expected to be the earnings of year 5, and then the approximate worth will definitely be $155,811 in the present dollar.

IRR method on the other hand is another sophisticated method of capital budgeting technique that is widely used. However, it very complicated to actually calculate by hand and a spreadsheet or scientific calculator is required. Companies would rather the calculations done in the form of annual rates of the return as opposed to the actual dollar returns. This makes it possible for them to make a comparison of several projects for purposes of rankings in order to ascertain which of the projects is likely to provide more bang for the particular buck. IRR method actually provides result of the rate of return (Gitman, 2009).

The most efficient capital structures for a manufacturing company and software development firm is the financial stability. This is fundamentally the ability of the firm to actually raise its capital during the bad times. It should not be surprising that the companies characteristically having no particular problem in raising capital whenever the earnings are strong and the sales are growing. The companies are expected to be very prudent when coming up with an effort aimed at raising capital during the good times and not actually stretching its capital any further. The lower the debt level of a company, the more financially flexible that particular company is likely to be. However, the software development firm has the highest cost capital since in very good times; the firm generates important amounts of cash and consequently the cash flow. Nevertheless, during the bad times the situation is reversed and the firm is in a position to actually borrow funds.

Being a mixture of the particular short term debt, long term debt, preferred equity as well as common equity of the company, capital structure of the company simply refers to how the firm is able to finance the overall growth and operations through the use of various sources of the funds. Debt in this case comes in the form of a bond issues or the long term notes that are payable, while on the other hand equity can be classified as the common stock, retained earnings, or the preferred stock. Moreover, the short term debt that includes the working capital requirements is also considered to be part of capital structure. In a nutshell, the capital structure is simply the debt to equity ratio of the firm.

Bibliography

Gitman, L. 2009, Principles of Managerial Finance (12th ed.). Pearson Prentice Hall: Boston, MA

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