Are There Any Similarities Between An Individual's Capital Budgeting Decision

What is capital budgeting? Are there any similarities between a firm’s capital budgeting decisions and an individual’s investment decisions?

Capital budgeting is known as investment appraisal. Any projects will have limited available capital at the given time and due to this reason, management needs to use capital budgeting techniques to determine which projects are deserve for an investment. Projects that have higher return on a period of time will be choose to invest such as investment property, develop projects and potential long-term investments.

Management will first assess the prospective of project's life time cash inflow and outflow to determine whether the return of the project will generate sufficient profit to make it worthwhile.

When r is 0%, the y-intercept is the project’s NPV and the x-intercept is the projects’ IRR. IRR of L is 18.1% and IRR of S is 23.6%. The project cross over at approximately 8.7%

F. (1) What is the underlying cause of ranking conflicts between NPV and IRR?

The scenario of NPV is positive but IRR is less than the minimum rate of return will lead to the conflicts between NPV and IRR. There is another situation of two mutually exclusive projects. One project only have to be choose if it is mutually exclusive that are said to be independent. For example, two investment such as Investment A and investment B. Investment A delivers a higher rate of return that is 25 percent within a shorter period and the IRR will be higher than the required return demanded that is ten percent. Investment B has lower rate of return than investment A that is 20 percent but is still higher than the required return demanded and is delivered over a longer period. While investment B has higher NPV than investment A. The IRR for investment A is larger than the IRR for

(1) Define the term modified IRR (MIRR). Find the MIRRs for Projects L and S.

The modified internal rate of return (MIRR) is a financial measurement of an investment. MIRR can be said as a better version of internal rate of return that can be used for capital budgeting. The problems that occur in IRR can be solved by using MIRR method such as more than one IRR with negative and positive cash flows. The assumption of the project cash flows are reinvested at IRR are not included. This makes MIRR has better signal of a project’s true profitability. Once there is conflict between IRR and NPV, MIRR method can be used. Project with higher MIRR should be preferred.

G. (2) What are the MIRR’s advantages and disadvantages vis-à-vis the NPV?

The advantage of MIRR is that it is an improved version of evaluating projects. It can be used to solve the problem of having multiple IRRs. For example, if you run IRR on a series of negative and positive cash flows , you will have two unique internal rate of return. The negative and positive cash flows will be treated equally if MIRR is used. Besides, a project’s cost of capital can be assuming reinvestment than its own IRR. It takes into a fact of the possibility reinvestment