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Capital budgeting is a financial technique used by businesses to evaluate potential investments based on cash flows rather than profits. There are two main types of capital budgeting: traditional and discounted cash flow. Traditional methods include payback period, which focuses on recovering investment costs, and accounting rate of return. Discounted cash flow methods, like net present value and internal rate of return, account for the time value of money by adjusting future cash flows. Capital budgeting is important for businesses to make accountable and measurable investment decisions and remain competitive.

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278 views

Reflection Paper Format

Capital budgeting is a financial technique used by businesses to evaluate potential investments based on cash flows rather than profits. There are two main types of capital budgeting: traditional and discounted cash flow. Traditional methods include payback period, which focuses on recovering investment costs, and accounting rate of return. Discounted cash flow methods, like net present value and internal rate of return, account for the time value of money by adjusting future cash flows. Capital budgeting is important for businesses to make accountable and measurable investment decisions and remain competitive.

Uploaded by

Rose Ramos
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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GRADUATE SCHOOL

Reflection Paper

Financial Management
Subject

Name: Course: Prof:

Topic:

A financial management technique used by businesses to choose which investments

to make is capital budgeting. It emphasizes cash flows above profits. We can better

understand how businesses and investors make decisions by understanding the various

capital budgeting techniques.

Capital budgeting can be classified into two types: traditional and discounted cash

flow. Within each type are several budgeting methods that can be used. Payback period is

the most widely used traditional measure for evaluating potential investments. Payback

period focuses on recovering the cost of investments. In order to produce a payback

calculation, the manager must list all tangible costs and benefits. From this, the

manager can then start to project the cumulative cash-flow throughout a period of time. On

the other hand, accounting rate of return method (ARR) helps in overcoming the

disadvantages of payback period method. ARR formula is helpful in determining the annual

percentage rate of return of a project.

Discounted cash flow (DCF) is a type of financial technique that determines whether

an investment is worthwhile based on future cash flows. Net Present Value (NPV), one of

the widely used DCF, takes account of the time value of money. This means that all cash-

flows are adjusted for inflation and other factors. The internal rate of return (IRR) is another

DCF used in capital budgeting to estimate the profitability of potential investments. IRR is a
discount rate that makes the net present value (NPV) of all cash flows equal to zero in a

discounted cash flow analysis. The profitability index (PI), another kind of DCF, referred to

as value investment ratio (VIR) or profit investment ratio (PIR), describes an index that

represents the relationship between the costs and benefits of a proposed project. The

profitability index is helpful in ranking various projects because it lets investors quantify the

value created per each investment unit.

Capital budgeting is important because it creates accountability and measurability.

Any business that seeks to invest its resources in a project without understanding the risks

and returns involved would be held as irresponsible by its owners or shareholders.

Furthermore, if a business has no way of measuring the effectiveness of its investment

decisions, chances are the business would have little chance of surviving in the competitive

marketplace.

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