Question

Write a 200 - 250 words post

Consider how the capital budgeting process develops for three differently sized organizations: a large organization with greater than $50 billion in annual sales, a medium-sized organization making $4–20 billion, and a small organization making under $4 billion.

• What are the main differences in how the capital budgeting process is developed and finalized for each size of organization?
• What financial tools are available?
• What other factors can play a role?

Answer 1

The bigger the size of the organization higher is the risk and complexity in the investment projects undertaken by the company unless it has a sufficient cushion of cash reserves. It has been observed that the bigger the size of firms in terms of turnover they tend to use more of discounting capital budgeting techniques than compared to smaller firms. NPV is the most preferred tool for measuring the investment viability and profitability. The primary reason being that NPV presents the most near to accurate measure of the future cash flows using a discounting rate to reflect time value of money. NPV is the excess of discounted cash flows over initial investment. A positive NPV is seen as a go ahead for the project whereas a project with negative NPV is not accepted. The other financial tools available for capital budgeting are Internal Rate of return and payback period calculation. The other factors that play an important role in capital budgeting process are:

1. The availability of working capital with the firm to meet short term financing needs

2. Government policies and tax rates

3. Supply of resources and manpower to execute the project as planned

4. The capital structure of the firm and the cost of capital

5. The opportunity cost of investing in the firm and the rate of return