CAPITAL BUDGETTING TOOLS 1

Capital Budgeting Tools

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CAPITAL BUDGETTING TOOLS 2

Generally, global companies have engaged in various businesses that have made decent
profits. It has resulted from international corporations and other investors who bring better
profitability levels. The international counterparts tend to offer appropriate extensive, and
effective programs through proper management of companies. The global company businesses
are offered various policies that are efficient and effective to the growth of the organizations.
Still, the policies ensure that better services are offered accordingly (Schill, 2020). To add more
value to the Company, there has to be an allocation of capital that will increase stakeholders'
value and determine how projects will be secure and affordable.
To secure better and appropriate company projects, the investors have to engage in
various methods essential in determining the Company's project cash flows for different years.
The investors ought to be cautious while undertaking effective measures that are resourceful in
attaining suitable results for the Company to grow. Regarding the task at hand, I shall focus on
the capital budgeting tools and further computations based on the projects and determine which
project suits best at ABC Healthcare Corporation (Senthilnathan, 2020). Also, I can focus on the
analysis and evaluation of the projects that will add the most value for the Company. In addition,
I shall include recommendations that will provide appropriate value to the organization.
Notably, the finance managers ought to consider what capital budgeting metrics should
be employed. The finance manager needs to allocate capital to areas that will increase
shareholder value and add the most value to the Company. Financial analyst managers tend to
oversee the financial conditions in companies`, therefore ensuring ongoing viability on
monitoring cash flows. Likewise, the financial analyst managers determine the levels of profits
and offer accurate information on cash flow finances (Senthilnathan, 2020). Also, the financial
managers have greater responsibilities that are extensive and depend heavily on the Company's
growth. Besides, the financial manager can specialize in the suitable financial aspects that ensure
companies gain affordable and reliable operations in the global economy.
Furthermore, suitable operations within a company intend to ensure that operations run
smoothly and effectively. It indicates that there shall be an upward trend with proper
management of finances through analysis done by the financial analysts' managers. The financial
analyst managers tend to forecast the projected cash flows of the projects, thus, employing
capital budgeting metrics that are suitable in determining which project gives the Company
appropriate opportunities to maximize stakeholders' values. To carry out various operations
within the Company, the financial managers have to maintain both regulatory and legal
necessities that are important (Senthilnathan, 2020). It's because both legal and regulatory
requirements are resourceful in obtaining an appropriate financial position for a firm. Still, the
financial managers are bound to have various techniques that are worthy in shaping and
recognizing the growth of the companies respectively.
Notably, financial analysts tend to offer accurate reports of finances that are efficient to
the Company. It considers a healthy growth in the Company's operations in an entire business
venture. The financial analyst managers tend to project financial projections, whereby the ABC
Healthcare Corporation can ensure that the projections could sustain the companies` welfare
(Senthilnathan, 2020). In addition, the financial managers within the ABC Healthcare
Corporation tend to ensure that they engage in managing financial risk losses that can negatively
affect the Company. Generally, the financial managers intend to assist companies' finances in
enabling sustenance on ABC Healthcare Corporation. It dramatically assists financial analyst
CAPITAL BUDGETTING TOOLS 3

managers in engaging in broader ranges within enterprises. Also, the financial managers are
suitable for working entirely for particular entities bound to offer substantial organizational
funds.
Similarly, the financial managers play significant roles in maintaining the Company's
expertise and institutes an excellent financial position. Also, it tends to resolve projection issues
within the Company; therefore, it ensures the smooth running of the ABC Healthcare
Corporation. Besides, it ensures that the Company's profitability levels are efficient and
effective. The financial managers can relate appropriately and reflect best on the financial
forecast of the organization (Islami & Hazhiyah, 2020). Moreover, it completes the projected
cash flows of the projects due to the computations. The computations are done using various
capital budgeting metrics effective in ABC Healthcare Corporation. Capital budgeting tends to
incorporate various applicable techniques in deciding on the correct times to invest in projects.
The investors involved in a company intend to incorporate various capital budgeting metrics in
companies. The tools are used to compute the future projected cash flows and compare the cash
flows projected to other upfront costs.
Correspondingly, capital budgeting tends to involve planning processes incorporated in
the Company's future investments. The financial manager ensures that the ABC Healthcare
Corporation businesses are effectively and efficiently, thus, being pursued and taken into account
collectively. Capital budgeting can develop a Company's financials worthy of bringing better
profitable levels and long-term investments. Additionally, several tools of capital budgeting are
applicable in determining the long-term investments in the ABC Healthcare Corporation (Islami
& Hazhiyah, 2020). To provide better Company's future investments, there have to be several
essential tools in solving the company financials. The capital budgeting metrics consist of net
present value, internal rate of return, the profitability index, the payback period, real option
analysis, and discounted cash flows. These metrics of capital budgeting have been further
discussed in length here below. Furthermore, various capital budgeting metrics could be used in
companies, are resourceful, and assist the company plan upcoming global investments.
Capital budgeting is of great significance, ensuring the creation of measurability and
proper accountability. Besides, suppose the Company's businesses seek to invest resources in
projects. In that case, capital budgeting offers the proper knowledge and skills on evading
problems brought into place by the stakeholders. The capital budgeting showcases how the
Company can attain desirable future investments worthy of the investors trying to pursue them
with diligence. It will significantly assist the ABC Healthcare Corporation (Islami & Hazhiyah,
2020). In general, capital budgeting is effective and efficient in accomplishing measurable ways
that bring appropriate financial profitability within the ABC Healthcare Corporation. By taking
into place projected businesses that will effectively affect the Company's progression in future
events. The Net Present Value is favorable among various financial analyst managers, thereby
having confidence in the Company's analysis.
According to Islam and his, counterpart Hazhiyah tend to imply that the Net Present
Value could be used in engaging in estimations of every probable projected value. The
discounted cash flow valuations could be applied while finding the Net Present Value. Also, the
discounted flow of cash assessment necessitates the size estimations of all increased flows of
cash from the projects done. Still, the discount rate adversely affects the Net Present Value;
therefore, creating suitable decisions could be worthy in attaining the proper rates. The financial
CAPITAL BUDGETTING TOOLS 4

analyst managers can reflect on the significant risks that may occur based on the volatility of
cash that is taken into account. In addition, financial analysts tend to use the arbitrage pricing
theory. The arbitrage pricing theory tends to hold the anticipated financial asset return
demonstrated for liner purposes to significant economic aspects, as well as sensitive changes that
are represented by co-efficient factors (2020).
Likewise, the Net Present Value tool is used appropriately in selecting what suitable
application is worthy for the Company. The tool mentioned above, cash flows anticipated at
different periodic times are discounted at specific rates. In addition, the cash inflows' present
values are compared to the inventive investments. Still, if there is a significant change between
the cash inflows, it has a positive outcome; thus, it is accepted and rejected. Also, the Net Present
Value considers the money value duration. It is bound to have a positive objective of maximizing
the owner's profits (Islami & Hazhiyah, 2020). The primary goal of the Net Present Value is to
increase the present value in the markets; thus, the decisions made tend to reduce the assets
values. To compute the Net Present Value, investors tend to minus the present value benefits
with the present value costs. Therefore, the Net Present Value (NPV) is equivalent to Present
Value Benefits (PVB) minus the Present Value of Costs (PVC).
Moreover, the payback period is another capital budgeting tool used to valuation the
company issues at hand. The capital budgeting tool mentioned above incorporates the necessary
period for the repayment of the original values of the investments. The payback period
intensifies how long commodities take time to repay and have the same commodity in the
Company (Schill, 2020). Also, the shorter the payback period, the longer it can prefer extensive
payback periods. Likewise, the tool for capital budgeting mentioned above is considered a
technique for analyzing serious qualifications and limitations for its usage; hence, it does not
consider funds, financial risks, and other vital considerations that are effective for the Company.
In addition, the payback period also showcases the number of years required for inflows
of cash to equate the cash outflows. What's more, the short payback period is preferable by
showing indications that projects would pay themselves within a short time. The payback period
is usually incorporated when the liquidity presents significant issues if the Company has
inadequate funds (Schill, 2020). Still, the projects may commence one after the other
respectively. The ABC Healthcare Corporation management will focus in length on
convalescing the original investments to participate in other projects. However, the payback is
easier to calculate once the establishment of cash flows is forecasted (Schill, 2020). Still, the
payback period tool cannot account for the time value for funds, thereby computing the payback
period, emphasizing received payments from one year to the following year.
The errors within the payback period tend to intensify the essential ideologies of finances.
Still, they are easily corrected by applying the discounted payback period model. The model
allows the Company investors to determine the time it takes for investments to be retrieved on a
discounted cash flow. The payback and the discounted payback period tend to exempt the cash
flows that occur to the project life ending as a recovered value. It also shows that the payback
period cannot be a direct profitability measure.
Additionally, the payback period tool of capital budgeting tends to negatively affect the
possibility of cash investments that may necessitate different projects (Schill, 2020). For
instance, when the bought assets ought to be considered, then its life doesn't prolong further than
the payback period; thus, there may not be ample time to make profits from the projects within
CAPITAL BUDGETTING TOOLS 5

the Company. In addition, the payback period tool of capital budgeting can be considered an
appropriate approach for valuations; hence if the liquidity is of significant deliberation, then the
payback period becomes essential to the Company (Schill, 2020). Also, to attain a reasonable
payback period, computations are done, whereby the Payback Period (PB) is equivalent to the
cash outlay (investment cash) divided by the annual cash inflow.
Correspondingly, the internal rate of return is another capital budgeting tool that involves
the discount rate that results in the net present value. Here, the Net Present Value is equivalent to
zero. The Net Present Value of various projects is associated with the inversed discount rate.
However, the discount rate intensifies; thus, the future flow of cash tends to be more ambiguous
and becomes worthless in terms of values. The higher internal rate of return in comparison to the
weighted average cost of capital tends to have profitable projected capitals that are reliable
(Siziba & Hall, 2021). In addition, the Internal Rate of Return can be computed by taking the
difference between the current future value and the original value by dividing the original value
then multiplying by 100. IRR is accountable for being associated with the outlay and other
proceeds connected to the Company's projects. The internal rate of return emphasizes the total
growth in the Company's investments and offers more information on the annual growth rate.
The tool can be computed on the activities that have ensured suitable investments; thus, results
are measured.
Collectively, the internal rate of return is not resourceful and viable in analyzing the
projected capital budgeting. Internal Rate of Return can be miscomputed and misinterpreted if
used in separate applicable scenarios. Likewise, where there is a positive flow of cash that tends
to be accompanied by negative cash flows and yet still by other positive cash flows, will
showcase that the IRR may demonstrate numerous prices. The Internal Rate of Return values
may have greater values that reach the Net Present Values to the ultimate zero. Still, the IRR
estimates individually on estimated figures that propose estimates on annual return values. The
IRR can acquire limitations whereby if there are heavily reliant on cash flow future projections
that are complex to predict intensively (Siziba & Hall, 2021). The ABC Healthcare Corporation
tends to compare the IRR inquiry to other adjustments. For instance, when projects have the
same IRR with inclusivity of less capital upfront; hence the simple investments within the
corporation may be selected despite the Internal Rate of Returns chosen. Additionally, the
investors ought to select investments with higher IRR. Instead, it should be above the set
minimum investors` threshold. Predicting the best Internal Rate of Return (IRR) will depend
highly on the cost of opportunity and capital of the stakeholder.
Nevertheless, the profitability index consists of another capital budgeting tool used by
companies. It is a measure of projects attractiveness within companies. The profitability index
intends to describe the relations between proposed projected benefits and other costs available.
Also, the profitability index (PI) can be computed as the ratio between the current value of the
expected cash flow and the original amount financed in the project (Siziba & Hall, 2021).
However, the Profitability Index tool is applicable, whereby it divides the projected inflows of
capital by the projected cash outflows, thus, defining the project's profitability. Still, a higher
project with a higher Profitability Index will be deliberated more appealing. To compute the
profitability index (PI), it can be solved by dividing the present value of the future expected cash
flow by the original amount of investments in the project. Additionally, the profitability index is
essential in assisting in ranking projects systematically, thus, allowing stakeholders in companies
to quantify the created value per every unit of investment (Siziba & Hall, 2021. When the
CAPITAL BUDGETTING TOOLS 6

profitability index value increases, the attraction of financials increases the projects proposed
respectively. Besides, when applying the profitability index, it is essential to consider how the
tool disregards the size of the project. In addition, the projects with more significant cash inflows
may bring outcomes of lesser profitability index computations because their marginal profits are
not high. To attain better appropriate computations on the profitability index of the ABC
Healthcare Corporation, investors can incorporate the formulae for profitability index as
equivalent to present value cash flows divided by the initial cash outlay. Further computations on
the profitability index will involve the Net Present Value benefits divided by Net Present Value
costs. In the long run, the projects with a greater profitability index are acceptable, so PI > 1.0 is
suitable.
Nevertheless, discounted cash flows are another capital budgeting tool that appropriately
values the project's security within a company. The tool is widely used to finance investments,
other business financial management. In addition, the discounted cash flows engage in value
estimations of investments based on future anticipated cash flows. Still, the tool tends to analyze
how much funds are created in the future due to the investment values. The discounted cash
flows are resourceful in ensuring that financial analysts look into capital budgeting decisions.
Similarly, the current value of expected future cash flow can be achieved by using the discounted
cash flow tool. While calculating the discounted cash flows, investors have to forecast the
expected cash flow from the investments, choose the rate of discounts, and then discount the
cash flows forecasted back to the present day (Bierman, 2020). Generally, if the discounted cash
flow showcases an above present cost of investments; hence the opportunities could bring about
affirmative profits. Still, the discounted cash flows tend to analyze the funds estimated that
stakeholders` would acquire from investments. Likewise, the discounted cash flow assessments
are suitable, whereby each investor can make payments in the current situations and more
anticipations of acquiring funds in the future times. Commonly, the discounted cash flows tend
to engage in analysis that showcases the current values of future expected cash flows through
discount rates.
Notably, real option analysis is a tool that could be incorporated in capital budgeting. The
real option analysis acts as a tool and a technique that can be useful in prioritizing adaptable
interventions, thereby considering the possibilities to make them adjustable in the future events
of the Company (Bierman, 2020). The tool can be used to determine whether interventions could
be delayed to test the intervention value that offers flexibility in the ABC Healthcare
Corporation. However, the real options analysis tool intends to allow for better possibilities on
making economic investment decisions that have been delayed over time. The capital budgeting
tool mentioned above allows appropriate and flexible benefits that are bound to be recognized
due to the nature of investments done in the Company (Bierman, 2020). The tool offers desirable
designs that evaluate massive strategies essential to the Company. In addition, the real option
analysis intends to acquire more significant levels of geographical details that are worthy of the
stakeholder's preferences. Moreover, the real option analysis will attempt to assess better choices
that the financial analyst managers will have soon. In addition, the analysts will tend to increase
the chances of future inflows of cash and decrease the future cash outflows. It also tends to
incorporate a sense of acceptance by the financial analyst in managing the projects and
ascertaining either to accept or reject the proposal collectively.
Convincingly, the financial analyst managers at ABC Healthcare Corporation intend to
engage in computing the project's analysis. Financial analysts have to incorporate capital
CAPITAL BUDGETTING TOOLS 7

budgeting techniques to acquire better results and determine among the three appropriate projects
(Bierman, 2020). The Company can select which projects provide the organization with better
chances to maximize shareholder value by engaging in computations. By employing the capital
budgeting metrics, they will be essential in attaining affordable results. The capital budgeting
tools will be resourceful to the growth of the companies.
PROJECT A: MAJOR EQUIPMENT PURCHASE
Purchasing cost- $10,000,000
Life of project in years 8
Reduction in cost per year 5%
Salvage value $500,000
Required rate of return 8%
Depreciation MACRS-7 years
Annual sales $20,000,000
Earlier Cost of sales (60% of sales) $12,000,000= 60/100*20,000,000=12,000,000 dollars
Tax rate 25%
Computations;
Annual sales-20,000,000
Cost of Goods Sold=$11,000,000{(5% of Annual sales (20,000,000)} then add the
purchases (10,000,000)
MACRS-7 years rates=14.29%
Annual depreciation=14, 29% of purchases (10,000,000) =1,429,000
Earnings before interest and taxes (EBIT) / Gross Income $8,571,000= (Purchases-
Annual depreciation)
Taxes (25%) / Income Taxes= 25% 0f 8,571,000=$2,142,750
Earnings after taxes / Net Income $6,428,250
Add Depreciation $1,429,000
Add: After tax salvage value
Cash Flows=Depreciations+ Net Income {($1,429,000+ $6,428,250=$7,677,250)}
Cumulative Cash Flows ($10,000,000 minus $7,677,250 =2,322,750)
Present Value factor (8%), 100%, and 1st year was 0.92 %( 92/100)
Present value of cash flows= {(0.92multiplied by (*) $7,677,250= $7,139,843}
CAPITAL BUDGETTING TOOLS 8

Present value of cash inflows $ sales plus he present value of cash flows= 53,142,750 +
(0.93 *7,677,250)} = $60,282,593
Present value cash outflows $10,000,000
Net present value = Present value of cash inflows - Present value of cash outflows
=$60,282,593 - $10,000,000
= $50,282,593
IRR (Internal Rate of Return) = computed by taking the difference between the current
future value and the original value by dividing the original value then multiplied by 100
= ($60,282,593-$53,142,750 divide by $20,000,000) *100
= 37.2%
Payback Period= Cash outlay (Investments) divided by the Annual Cash Inflow
=$7,677,250/$6,428,250
=1.19
Profitability Index (PI) = divide the present expected cash flow value by the initial investment
project amount

PROJECT B: EXPANSION INTO THREE ADDITIONAL STATES

Initial Cost $7,000,000
Life of a project in years 5
Annual Depreciation (using straight line) $1,400,000
Net working capital $1,000,000
Required rate of Return 12%

Earlier Cost of sales (60% of sales) $12,000,000

Increase in sales and revenue per year 10%
Tax rate 25%
CAPITAL BUDGETTING TOOLS 9

Computations.
Purchasing Cost $7,000,000
Annual Sales $20,000,000
Cost of goods sold $13,000,000= (Annual sales-Purchasing cost)
Annual Depreciation $1,400,000
Earnings before interest and taxes (EBIT) = (Purchases-Annual depreciation) = ($7,000,000-
$1,400,000) = ($5,600,000)
T ax (25%) of the Purchasing Costs = $1,750,000
Earnings after tax= EBIT- Tax rates [(7,000,000- $1,750,000= $ 5250, 000)]
Plus Depreciation $1,400,000
Net working capital ($1,000,000)
Cash flows (total cash flow will be EBIT plus the Depreciation) = {($5250, 000+$1,400,000=
$6,650,000)}
Cumulative Cash flows = (total purchases less the total cash flows
= (cost of purchasing plus the networking capital) less total cash flows
= (1,000,000+7, 0000, 000) - 6,650,000
=$1,350,000
Present value factor (12%) 1.00 % and 0.88% in the first year
Present value of cash flows ($8,000,000) $6,205,357
Present value of cash inflows $30,259,712
Present Value of Cash outflows $8,000,000
Net Present Value = Present Value of cash inflows - Present Value of cash outflows
= $ 42,181,425- $ $8,710,521
= $33,470,904
IRR (Internal Rate of Return) = Can be calculated by taking the difference between the
current future value and the original value by dividing the original value then multiplied by 100
= $42,181,425- $ $8,710,521/ $8,710,521)*100
=79.35%
Payback Period= Cash outlay (Investments) divided by the Annual Cash Inflow
 CAPITAL BUDGETTING TOOLS
10

=$9, 929, 993, 94/ $8,710,521

= 1.14
Profitability Index (PI) = present value of cash inflows/ present value of cash outflows
= $47,298,129.03/$8,710,521
= 5.43
PROJECT C; MARKETING/ADVERTISING CAMPAIGN
Annual cost $2,000,000
Life of project in years 6
Required rate of return 10%
Earlier Annual sales $20,000,000
Earlier Cost of Sales (60% of sales) = $12,000,000
Increase in sales and revenue per year 15%
Tax rate 25%
Marketing / Advertising cost $2,000,000
Present value of Annual marketing cost $8,710,521
Annual sales $23,000,000
Cost of the Goods sold= Annual sales MINUS the Present value of Annual marketing cost
= $ 23,000,000 -$8,710,521
=$14,289,479
Earnings before interest and taxes (EBIT= Annual sales - Cost of the Goods sold
=$ 23,000,000 -$14,289,479
=$8,710,521
Taxes (25%) of Earnings before interest and taxes (EBIT) = 25% * $8,710,521
=$2,177,630
Earnings after taxes= Earnings before interest and taxes (EBIT) less Taxes
=$8,710,521-=$2,177,630
=$ 6,532,891
Cash Flows will be equivalent to earnings after taxes=$ 6,532,891
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Present value factor (10%) 1.00 and value factor rates on the first year 0.91
Present value of cash flows ($8,710,521) $6,272,727
Cumulative Cash flows = ($1,810,521)
Present value of cash inflows $42,181,425
Present value of cash outflows $8,710,521
Net Present Value = Present Value of cash inflows - Present value of cash outflows
= $42,181,425 -$8710521
=$33,470,898
IRR (Internal Rate of Return) = Can be calculated by taking the difference between the current
future value and the original value by dividing the original value then multiplied by 100
= $42,181,425-$23,000,000/$ 23,000,000 multiplied by 100
=83.40%
Payback period=Cash outlay (Investments) divided by the Annual Cash Inflow
=$14,289,479/$$8,710,521
= 1.64
Profitability Index (PI) = present value of cash inflows/ present value of cash outflows
=$42,181,425/$8,710,521
=4.84
It is recommendable that they have a payback period of less than two
years of all three projects. Each project is pre-determined with a required rate of return based on
how risky the investment was. The Net present value is greater than 0, and the internal rate of
return is greater than the cost of capital so that this project would be accepted as well. The IRR
for this project reveals that it has a higher magnitude and better timing of incoming returns. The
higher the IRR, the less risky the project. The payback period is less than 1.25 years, which
supports the risk extent of IRR. Between Project A and Project B, Project B carries less risk,
thereby making project B more adequate for the development of the ABC Healthcare
Corporation company.
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Reference
Bierman, H. (2020). Capital budgeting. Handbook of financial planning and control, 77-89.
Islami, R. C., & Hazhiyah, A. U. (2020, September). Correlation model between estimated
project cost and net present value (NPV) on transportation infrastructure
projects using public-private partnership (PPP) scheme. In Journal of
Physics: Conference Series (Vol. 1625, No. 1, p. 012029). IOP
Publishing.
Mujahed, M. M., & Elshareif, E. E. (2017). Internal Rate of Return (IRR): A New Proposed
Approach. In Leadership, Innovation and Entrepreneurship as Driving
Forces of the Global Economy (pp. 761-767). Springer, Cham.
Schill, M. J. (2020). The Profitability Index.
Senthilnathan, S. (2020). Capital Budgeting–The Tools for Project Evaluation. Available at
SSRN 3748067.
Siziba, S., & Hall, J. H. (2021). The evolution of the application of capital budgeting techniques
in enterprises. Global Finance Journal, 47, 100504.