Question

Which budgeting method requires the user to impute the appropriate rate of interest?

Answer 1

• CAPITAL BUDGETING TECHNIQUES

Any investment decision depends upon the decision rule that is applied under circumstances. However, the decision rule itself considers following inputs.

The effectiveness of the decision rule depends on how these three factors have been properly assessed.

Estimation of cash flows require immense understanding of the project before it is implemented; particularly macro and micro view of the economy, polity and the company.

Project life is very important, otherwise it will change the entire perspective of the project. So great care is required to be observed for estimating the project life.

This chapter is focusing on various techniques available for evaluating capital budgeting projects.

1. It should consider all cash flows to determine the true profitability of the project.

2. It should provide for an objective and unambiguous way of separating good projects from bad projects.

3. It should help ranking of projects according to its true profitability.

4. It should recognize the fact that bigger cash flows are preferable to smaller ones and early cash flows are preferable to later ones.

5. It should help to choose among mutually exclusive projects that project which maximizes the shareholders’ wealth.

6. It should be a criterion which is applicable to any conceivable investment project independent of others.

A number of capital budgeting techniques are used in practice. They may be grouped in the given two categories: -

1. Capital budgeting techniques under certainty; and
2. Capital budgeting techniques under uncertainty