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
Full Answer Section
- The risk of the investment: The risk of the investment is another important factor to consider. Investments with higher risk typically have higher expected returns. However, it is important to make sure that the expected returns are high enough to compensate for the risk.
- The company's financial situation: The company's financial situation is also important to consider. If the company is not financially strong, it may not be able to afford to make a large investment.
Here is an example of a business investment venture and how I would use capital budgeting to ensure it is a good investment:
The company I work for is considering investing in a new piece of equipment that would allow us to automate a portion of our manufacturing process. The cost of the equipment is $1 million, and we expect it to generate $200,000 in annual cash flows for the next five years. The risk of the investment is relatively low, as the equipment is a proven technology.
The NPV of the investment is $300,000. This means that the investment is expected to generate $300,000 in profits over its lifetime, after taking into account the cost of the investment and the time value of money.
The company's financial situation is strong, so we have the ability to afford the investment. Therefore, I would recommend that the company make the investment in the new equipment.
In addition to the factors mentioned above, I would also consider the following factors when using capital budgeting techniques to determine whether a business investment is a good idea:
- The company's strategic goals: The investment should be consistent with the company's strategic goals.
- The investment's impact on the company's cash flow: The investment should not have a negative impact on the company's cash flow.
- The investment's impact on the company's risk: The investment should not increase the company's risk to an unacceptable level.
By considering all of these factors, I can make an informed decision about whether a business investment is a good idea.
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 factors:
- The cost of the investment: The initial cost of the investment is an important factor to consider, as it will determine how long it will take the investment to break even.
- The expected cash flows: The expected cash flows from the investment are also important to consider. These cash flows can be used to calculate the net present value (NPV) of the investment, which is a measure of the investment's profitability.