Capital Budgeting Practices

Capital Budgeting Practices

Either constructing a plant or investing in an outside venture, investors and companies undertake a capital budgeting. However, the process of evaluating potential projects differs between large and small companies. Notably, there is an excellent use of discounted cash flow techniques to assess the rate of return on a project.  Other methods include simple payback, weighted average cost, and cost of a specific source of funds. While calculating the hurdle rate, the capital budgeting process should not be used while competing against other project but in relation to profits. Furthermore, while calculating estimated benefits from a project, various factors are taken into consideration, including the size of the project, operations, and risk assessments.

Investment decisions form a fundamental aspect of budgeting and determine the returns of the project. Here the project managers have a role to play in making a decision that benefits investors. At the same time, the project saves costs on the process—for instance, enhancing the manufacturing process while reducing the cost and increasing the probability of higher return. Apart from the authority that decides to enact and start a project, analyzing the project also vital to the outcome. Financial analysis involves the evaluation of a project, which is different between large and small companies. As a result, small companies were found to simplify DCF while large firms did a comprehensive analysis that involved sensitivity analysis.

In regards to the rates of return, many companies had a typical capital budgeting process. Besides, the companies included a hurdle rate for project approval. The defector hurdle rate, when incorporated in budgeting, creates a better viewpoint on the return of the company and the percentage of risk in the investment. The firm indicated uniformity hurdle rate and those that were high, especially for the small companies. Those that showed a lower level of decision making were found to be linked to small companies. As a result, the management team incorporats past decision to determine the hurdle rate and thus, the budget for the desired project..

The twelve companies that were analyzed produced unique information that indicated the various techniques employed to decide on a project or investment. The top corporate management, together with showed incapability of making a concrete decision for the small project primarily because of the high cost that is involved. Since the interview was the primary source of information, the companies provided vital information about the level of a company in making investment decisions. Notably, the small project which make significant impacts on the company are usually neglected. These decisions resulted in flexibility in budgeting, especially in the smaller projects.

Notably, the high hurdle rate involved in small projects was noted in most of the companies. Here, projects with disadvantages like less favoured companies were compensated for hurdle rates determination. Further, uncertainty was included in the final decisions and created unprecedented risk levels. Therefore, the study concluded that the involvement of management in decision making plays a vitalpart in capital budgeting. In addition, analyzing risks and the success of the company created an uncertainty level. Among the challenges found included communication problem in large projects and financial discomfort when smaller projects were involved. Therefore the information on the project is paramount as it provides both internal and external evidence and reduces the uncertainty in projects. Accordingly, capital budgeting varies in the plant division as well as with the committee, and board level.