When answering the question focus on key capital budgeting concepts and tools; t

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When answering the question focus on key capital budgeting concepts and tools; the time value of money, return on investment, discounted cash flow techniques, payback period, and internal rate of retur.n

Question:

While financial analysis is CRITICAL and should be a key part of any significant investment decision, there are other (non-financial) considerations that will also be considered by management before making a final decision. Just because a project or proposal has a positive NPV, does not necessarily mean it should be undertaken. What are some of the non-financial considerations that should be considered by management?

Share a project that you led that had strong financials but was not approved and discuss whether you would have proceeded differently if you were the decision maker.

Explanation / Answer

Capital budgeting, or investment appraisal, is the planning process used to determine whether an organization's long term investmentssuch as new machinery, replacement machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structure (debt, equity or retained earnings). It is the process of allocating resources for major capital, or investment, expenditures.One of the primary goals of capital budgeting investments is to increase the value of the firm to the shareholders.These methods use the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper - such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period.

The internal rate of return (IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a commonly used measure of investment efficiency.

The IRR method will result in the same decision as the NPV method for (non-mutually exclusive) projects in an unconstrained environment, in the usual cases where a negative cash flow occurs at the start of the project, followed by all positive cash flows. In most realistic cases, all independent projects that have an IRR higher than the hurdle rate should be accepted. Nevertheless, for mutually exclusive projects, the decision rule of taking the project with the highest IRR - which is often used - may select a project with a lower NPV.In considering how non-financial information might add value to internal decision making or reporting, think about what benefits may arise (ie improved stakeholder engagement, performance management) and the associated costs of collation, interpretation, and risk to reputation. Once you have a clear understanding of your organisation’s strategy you will be in a stronger position to select what non-financial information has causal relationships with “successful” outcomes (and the avoidance of “unsuccessful” outcomes).

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