Conclusions about capital budgeting The decision process Before making capital b

Question

Conclusions about capital budgeting The decision process Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm's strategic goals. Companies often use several methods to evaluate the project's cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. The discounted payback period improves on the regular payback period by accounting for the time value of money. For most firms, the reinvestment rate assumption in the MIRR is more realistic than the assumption in the IRR. Managers have been slow to adopt the IRR, because percentage returns are a harder concept for them to grasp. is the single best method to use when making capital budgeting decisions.

Explanation / Answer

1st and 2nd statement about capital budgeting are valid !!

1)The discounted payback period improves on the regular payback period by accounting for the time value of money.

One of the major disadvantages of regular pay-back period is it ignores time value of money.To counter this limitation another prodecure as discounted pay-back period is followed,which accounts time value of money by discounting the cash flow of the project.Discounted Pay-back period is more reliable than regular pay-back period as it accounts the time value of money. If the project has negative net present value it will not pay its initial investment.

2)For most firms ,the reinvestment rate assumption in the MIRR is more relaistic than the assumption in the IRR.

While the IRR assumes the cash flow from a project are reinvested at IRR, MIRR assumes the cash flow from project are reinvested at firm's cost of capital,and the initial outlay are financed at firm's financing cost.Therefore, MIRR more accuarately reflects the cost and profitability of a project.

Net present value is the single best method to use when making capital budgeting decision as there are more limitation in another method of pay-back period and IRR. As explained above MIRR is more reliable than IRR and Discounted pay back period is more reliable than regular pay-back period

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