Corporate finance (Accounting) Essay Example | Topics and Well Written Essays - 2000 words

Corporate finance (Accounting) - Essay Example By capital budgeting of an entity we mean a detailed planning of capital assets. The decision about capital budgeting helps in determining whether or not the money should be invested in long term projects. When we consider the Research and Development projects of G&H PLC for the purpose of better decision making, we find that the fundamental project evaluation techniques like Pay back period, ARR (Accounting or Average Rate of Return), NPV (Net Present Value), or IRR (Internal Rate of Return) are applicable. The initial outlay or initial investment of the project of G&H Plc is 4m, i.e. 4000000. Pay Back Period= 4000000, i.e. ( '000s), Option A= 4000/468= 8.547 years approximately, and for option B= 4000/305= 13.114years approximately. If both options are considered in fact option A has 8.5years and B has more than 13years, but option B has a much higher return than option A, so it should be preferred. Assume that net income for the first year is taken for both options, and there is no scrap taking place. Both these options are not equal since the profit in Option B starts accruing at a much higher level as compared to the profits of Option A. So, ARR fails to give stress for the concept of Time Value of Money. 1RR= It means, the sum total of cash inflows after discounting equals to the discounted cash outflows. Under IRR, the discount rate makes the NPV of the project equal to zero. Assume that, here, in both options the discounted value is in between 10% and 12%. Take inflow of 10% given in the table above and 12% factor for Option A assumes 750.9 and Option B assumes 1750.3 approximately. IRR= r+ PVCFAT_ PVCO/PV*r Here, PVCO= present Value of cash outlay.