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Business Capital

When it comes to investing business capital, a financial manager would want to know whether that investment is a good one. The capital budgeting techniques reviewed this week provide the financial manager with tools to make good investment decisions.

Imagine that you are a financial manager for a medium-sized company

Describe how you would use capital budgeting techniques to determine whether a business investment is a good idea.
Give an example of a business investment venture and how you would use capital budgeting to ensure it is a good investment

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Sample Answer

As a financial manager for a medium-sized company, I would use capital budgeting techniques to determine whether a business investment is a good idea by considering the following:

  • The net present value (NPV) of the investment. The NPV is the difference between the present value of the future cash flows from the investment and the initial cost of the investment. If the NPV is positive, the investment is expected to generate a profit.
  • The internal rate of return (IRR) of the investment. The IRR is the discount rate that makes the NPV of the investment equal to zero. The IRR is a measure of the profitability of the investment.
  • The payback period of the investment. The payback period is the amount of time it takes for the initial cost of the investment to be recouped through the cash flows from the investment.

Full Answer Section

I would also consider the following factors when making an investment decision:

  • The risk of the investment. The risk of an investment is the chance that the investment will not generate the expected cash flows.
  • The liquidity of the investment. The liquidity of an investment is the ease with which the investment can be sold.
  • The strategic fit of the investment. The strategic fit of an investment is how well the investment aligns with the company’s overall business strategy.

For example, let’s say that I am considering investing in a new piece of equipment that will automate a manufacturing process. The NPV of the investment is $100,000, the IRR is 15%, and the payback period is 3 years. The risk of the investment is moderate, and the liquidity of the investment is good. The strategic fit of the investment is excellent, as it will allow the company to reduce costs and improve efficiency.

Based on these factors, I would conclude that the investment is a good idea. The NPV, IRR, and payback period all indicate that the investment is likely to be profitable. The risk of the investment is moderate, which is acceptable. The liquidity of the investment is good, so it should be easy to sell if necessary. The strategic fit of the investment is excellent, as it will allow the company to reduce costs and improve efficiency.

I would then need to present my findings to the company’s management team and recommend that they approve the investment.

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