Capital Budgeting For Long-Term Financial Success Of The Organization

Capital budgeting

Capital budgeting is a technique of investment proposal and appraisal which is basically a planning process that is used by the organizations and the financial manager of a business to analyze that whether the project or the business plan would offer the long term returns to the business or the investment into that business would lead to the company towards the loss (Kaplan and Atkinson, 2015). The capital budgeting techniques process evaluates the new machinery, new business plan, expansion of the business, replacement of the property, plant and machinery, research and development projects, new products, new planets etc which are worth of the funding of huge cash equivalents and the cash through the overall capital structure of the firm. It includes the equity, debt and retained earnings.

Applying the capital budgeting technique at the initial phase of a business leads to the business owners and the executives of the business at a better way of decision making. This process makes it easier for the business owner to make a decision about the acceptance of the new project or not. This process explains about the allocating of the resources for the investment or major capital or expenditure (Jiashu, 2009). One of the important goals of the capital budgeting investment is to enhance the value of the business among the shareholders and at the security market.

In the report, a new business has been evaluated and it has been measured that whether the business would offer higher returns to the company or not. The new business plan explains about a new business which would be start up by the entrepreneurs in the South Africa. The business would be related to the manufacturing and delivering of dairy products in the South Africa market. The case explains that the Minenhle and Bokamosos, two friends would start this business. The report focuses on the overall cost and the revenues from the business and measures that whether the investment into the company would be profitable for the business or not.  In the report, various techniques of the capital budgeting has been applied on the business to measure the overall position of the business.

Business owners and the executives of the business are always responsible for evaluating and managing the different functions of the business. Corporate finance is also among those tools which are applied by the financial manager of the business to conduct the capital budgeting process on the business. Financial planning process contains the various processes which must be followed by business owners and the entrepreneurs to accomplish the carious goals of the business (Horngren, 2009). Capital budgeting is a tool which is used by the business to find out the profitability level of the long term investment.

Capital budgeting involves various corporate finance formulas to assess the financial return of the business opportunities of the business. The mathematical calculations offer the business owners about the quantitative analysis which is used on the basis of the internal and external economical and financial data. Business owner use the corporate finance formulas to take the guess work about the various important decisions related to the capital of the company and the investment into that particular project. Capital budgeting could also use the qualitative analysis which is absolutely necessary for the business owners to make a decision about the process of the company (Hillier, Grinblatt and Titman, 2011). Qualitative analysis is the personal judgement of the business owners and he managers about the financial analysis.

Types of capital budgeting

The capita budgeting tools are of various types which include the different formulas and result about the new business and the investment proposal of the company. Mainly, the types of the capital budgeting include net present value tool, payback period, discounted payback period, average rate of return, internal rate of return, profitability index etc. The net present value formula estimates the cash outflow of the business and future cash inflow of the business in current value (Gapenski, 2008). The future cash inflows of the company are multiplied by the present value factor of the market to identify the current profitability position of the business.

On the other hand, the discounted payback formula estimates the cash outflow of the business and future cash inflow of the business in current value. The future cash inflows of the company is multiplied by the present value factor of the market to identify the total time period in which the total invested amount in the business would be get back by the company on the basis of the present value factor (Higgins, 2012). In addition, the payback formula estimates the cash outflow and future cash inflow of the business. The payback period calculations is done in which the total invested amount in the business would be get back by the company.

Further, the internal rate of return concept briefs that the internal return of a project must be higher than the discount rate of the company as the internal rate of return presented about the total return from the project and the discount rate explains about the total cost of the company firm. In addition, the profitability index and the accounting rate of return tools also explain about the associated profit of a project.

These tools help the company to make different outcomes about the project and the performance.

Uses of capital budgeting:

Capital budgeting process and the financial process of an organization works in a cycle. As some rules and the goals and objectives are set by the business owners and the financial managers to meet, they use the qualitative and quantitative analysis to measure the performance and the make the business decisions. The tools of the capital budgeting offers the requisite analysis information about the objectives and the goals of the business in the process of financial planning and set up a new business (Ross et al, 2007). business owners combines all the business management method in the business in order to ensure that the business owners evaluate the financial return of the business decisions rather than accepting the opportunities in order to sake the growth and the potential increment in the business.

Effects of capital budgeting:

The capital budgeting process is used by the owners of the business and the financial manager to obtain the funds from the banks and the investors of the company. These tools are use by the companies in making various decisions about the capital structure, source of finance, investment into the project etc. these tools help the small business, medium capital business and the large business to make decision about various financial related issues of the business. It evaluates all the related expenses and the revenue of the business to measure the overall performance and the position of the business (Ross et al, 2008).

Uses of capital budgeting

Capital budgeting is an important process as it creates the measurability and the accountability of the business. Any business which seeks to invest into project in order to enhance the investment amount and the return without evaluating the risk and return factor of the business could lead to the investment at a wrong way. The importance of the capital budgeting is as follows:

• Capita budgeting helps a business to develop and formulas the long term objectives and the strategic goals of the business. The capital budgeting process measure the overall performance of the business plan and offer a base to the business owners to make an idea about the goals and the objectives of the business (Barlow, 2006).
• Capital budgeting process evaluates that what would be the profitability level of the business and how much would it take to the business to get back the amount which has been invested in the project.
• It estimates all the cash outflows and future cash inflows of the company to measure the overall financial performance of the company.
• It facilitates the communication of the required information about the business plan to the related parties (Reilly and Brown, 2011).
• It controls and monitors the overall expenditure and the income of the company to measure the overall performance of the business.
• It is one of the better tools of the corporate finance which offers a base to the business owners to make a decision about the financial performance of the company.

Further, the disadvantages of the business have also been measured to identify the related cons of the capital budgeting process of the business. The drawbacks of the capital budgeting process are as follows:

• All the capital budgeting techniques presume that numerous investment proposal under the consideration are usually exclusive that might not be true on the practical scenario in some particular situation of the business.
• Urgency is also a limitation of the capital budgeting process and the decision making process of the business (Radebaugh, Gray and Black, 2006).
• Capital budgeting techniques require future cash outflow and inflow estimation. However, the future is always certain and the data collected for the future cannot be certain. So, it is obvious that the data collected in reference with the future cash inflow are not correct.
• Further, uncertainty and the risk position of the business is also one of the biggest limitations of the capital budgeting techniques.
• There are few other factors of the business as well such as the employees morale, firm’s good will etc that could not be correctly quantified but it otherwise substantially influence the decision making process and the capital decision of the business (Phillips and Stawarski, 2016).

On the basis of the overall evaluation on the capital budgeting, it has been measured that the capital budgeting is one of the finest tool to measure the overall performance of the business. Capital budgeting involves various corporate finance formulas to assess the financial return of the business opportunities of the business. The mathematical calculations offer the business owners about the quantitative analysis which is used on the basis of the internal and external economical and financial data.

Business owners and the executives of the business are always responsible for evaluating and managing the different functions of the business. Capital budgeting is also among those tools which are applied by the financial manager of the business to conduct the capital budgeting process on the business (Peterson and Fabozzi, 2002). Financial planning process contains the various processes which must be followed by business owners and the entrepreneurs to accomplish the carious goals of the business. The study explains that the entire related factor must be evaluated by the business after analyzing and measuring all the related factors of the business so that a better analysis could be done and a better decision could be made for the business.

Minenhle and Bokamosos are the two friends. Both of them are working in the South Africa market from last 10 years and now they have decided to quit the job and open their own business. They would start a new business in the market. The new business plan explains about a business which would be start up by the entrepreneurs in the South Africa. The business would be related to the manufacturing and delivering of dairy products in the South Africa market.

The case mainly explains that for starting the business, they have to set up a plant for the production of the dairy products. The cost of the new plant of the business would be R 10,000,000. It further explains that the plant would be run for the 5 years. For running the operations at the plant, working capital worth 15,00,000 would be required by the business. Further, it has been found that the total sales units of the product would be 100000 in first year which would rise by 10% in next 2 years and after the 3^rd year, the sales unit of the company would be lowered by 15%. The sales price of the project would be 100 which would rise by 4% in each of the year.

Effects of capital budgeting

It has also been measured that the installation cost of the plant would be 10000 and the expenses of the production of the company would be 50% of the total revenue of the business. The operating cost of the business would be R 1500000 in initial year which would be increased by 3% each year. Further, it has been measured that the depreciation has been charged on the plant on the basis of straight line method. The taxes of the company would be 30%. The life time of the project is 5 years. The discount rate of the business would be 15%. The plant would have no scarp value after 5 years and the overall position of the company would be lower by that time.

The above given case of Minenhle and Bokamosos has been measured on the basis of the capital budgeting analysis to measure the risk and the return position of the company. It has been measured that the Minenhle and Bokamosos has decided to measure the returns from the project firstly so that new issues and risk could be rise in future of the business (Palicka,, 2011). Firstly, the cash position of the business has been calculated which is as follows:

Minenhle and Bokamosos business project
		Year 1	Year 2	Year 3	Year 4	Year 5
Initial Outlay	10,000,000
Revenues		10,000,000	11,440,000	13,087,360	11,569,226	10,227,196
Expenses	10,000	5,000,000	5,720,000	6,543,680	5,784,613	5,113,598
Expenses		1,500,000	1,545,000	1,591,350	1,639,091	1,688,263
EBDT		3,500,000	4,175,000	4,952,330	4,145,523	3,425,335
Less: Depreciation		2,000,000	2,000,000	2,000,000	2,000,000	2,000,000
EBT		1,500,000	2,175,000	2,952,330	2,145,523	1,425,335
Less: Taxes		450,000	652,500	885,699	643,657	427,600
EAT		1,050,000	1,522,500	2,066,631	1,501,866	997,734
ADD: Depreciation		2,000,000	2,000,000	2,000,000	2,000,000	2,000,000
cash flow	17,138,731	3,050,000	3,522,500	4,066,631	3,501,866	2,997,734
Changes in Working capital	1,500,000					1,500,000
Total cash flow	5,628,731					4,497,734
Working Note:
Sales unit		100000	110000	121000	102850	87422.5
Sales price		R                 100.00	R                  104.00	R                  108.16	R                      112.49	R                116.99
Revenue		R     10,000,000.00	R      11,440,000.00	R      13,087,360.00	R          11,569,226.24	R    10,227,196.00

(Zimmerman and Yahya-Zadeh, 2011)

Cash flow analysis is an examination on the cash outflows and inflows of a project or a business in a particular time period. The analysis starts from the opening balance of the cash position of the company which leads to the ending cash position of the business. The cash flow analysis is mostly used by the businesses to make financial decisions (Ward, 2012). On the basis of the cash flow analysis of the business, it has been measured that overall revenue of the business would be enhanced in next 5 years as well as the total cash flow position of the business would be better and would be managed by the business in such a manner that better study could be performed in the business.

After that, net present value of the business plan has been calculated. The net present value tool estimates the cash outflow of the business and future cash inflow of the business in current value (Zabarankin, Pavlikov and Uryasev, 2014). The future cash inflows of the company are multiplied by the present value factor of the market to identify the current profitability position of the business. It measures the overall profitability position of the project on current data. The calculations and the analysis of net present value of the company are as follows:

calculations of net present value of Minenhle and Bokamosos business project
Years	Cash Outflow	Cash Inflow	Factors	P.V. of Cash Inflow	P.V. of Cash Outflow
0	R      11,510,000.00		1.00		R          11,510,000.00
1		R       3,050,000.00	0.87	R        2,652,173.91
2		R       3,522,500.00	0.76	R        2,663,516.07
3		R       4,066,631.00	0.66	R        2,673,875.89
4		R       3,501,865.83	0.57	R        2,002,203.16
5		R       4,497,734.35	0.50	R        2,236,168.88
				R      12,227,937.91	R          11,510,000.00
NPV= Total Cash Inflow-Total cash outflow	R           717,937.91

On the basis of the net present value calculations, it has been found that the total cash outflow of the business would be R 1,15,10,000 and the cash inflow of the business would be $ 1,22,27,938. It leads to the net present value of the business which is $ 7,17,937.91. It explains that the net present value of the project is positive and briefs that the project is quite beneficial for the company. If the Minenhle and Bokamosos would invest into the project then they would be able to generate huge profit from the business (Weston and Brigham, 2015).

Further, the internal rate of return tool has been used to measure the business plan of the company.  The internal rate of return concept briefs that the internal return of a project must be higher than the discount rate of the company as the internal rate of return presented about the total return from the project and the discount rate explains about the total cost of the company firm (Weaver, Weston and Weaver, 2001).  Internal rate of return is the rate where the NPV of a project becomes zero. The calculations of the IRR of the business plan are as follows:

Calculation Of IRR
Years	Cash Outflow	Cash Inflow	Net cash inflows
0	11510000.00		-11510000.00
1		3050000.00	3050000.00
2		3522500.00	3522500.00
3		4066631.00	4066631.00
4		3501865.83	3501865.83
5		4497734.35	4497734.35
IRR		17%

(Voelkl and Fritz, 2017)

On the basis of the internal rate of return calculations, it has been found that the total cash outflow of the business would be R 1,15,10,000 and the cash inflow of the business would be different in all the 5 years due to different revenues and the expenses of the company. On the basis of these figures, it has been measured that the internal rate of return of the project is 17%. It explains that the internal rate of return of the project is higher than the discount rate of the company and briefs that the project is quite beneficial for the company (Tsanakas and Millossovich, 2016). If the Minenhle and Bokamosos would invest into the project then they would be able to generate huge profit from the business.

In addition, the payback period of the business has been measured. The  payback formula estimates the cash outflow and future cash inflow of the business. The payback period calculations is done in which the total invested amount in the business would be get back by the company (Tian and Jiang, 2015). The calculations of payback period of the business plan are as follows:

Calculation Of Payback period
Years	Cash Outflow	Cash Inflow	Cash flows	CF
0	11510000.00		-11510000.00	-11510000.00
1		3050000.00	3050000.00	-8460000.00
2		3522500.00	3522500.00	-4937500.00
3		4066631.00	4066631.00	-870869.00
4		3501865.83	3501865.83	2630996.83
5		4497734.35	4497734.35	7128731.18
				3.21

(Chittenden and Derregia, 2015)

The calculations explains that the total invested amount in the business would be get back by the company in 3.21 years and the overall life time of the business plant is 3.21 years. It explains that the amount would be got back by the company within the life time of the machinery and thus it is a better choice for the purpose of investment (Burns and Walker, 2015).

Further, the study has been performed on discounted payback period. The discounted payback formula estimates the cash outflow of the business and future cash inflow of the business in current value (Madhura, 2011). The future cash inflows of the company is multiplied by the present value factor of the market to identify the total time period in which the total invested amount in the business would be get back by the company on the basis of the present value factor. The calculations are as follows:

Calculation Of discounted Payback period
Years	Cash Outflow	Cash Inflow	PV factor	P.V.	CF
0	-11510000.00		1.000	-11510000.00	-11510000.00
1		3050000.00	0.870	2652173.91	-8857826.09
2		3522500.00	0.756	2663516.07	-6194310.02
3		4066631.00	0.658	2673875.89	-3520434.13
4		3501865.83	0.572	2002203.16	-1518230.97
5		4497734.35	0.497	2236168.88	717937.91
					4.76

The calculations explains that the total invested amount in the business would be get back by the company in 4.76 years and the overall life time of the business plant is 5 years. It explains that the amount would be got back by the company within the life time of the machinery and thus it is a better choice for the purpose of investment (Kinsky, 2011).

Lastly, the profitability index of the project has been calculated which explains about the profitability ratio of the business (Levin and Hallgren, 2017). The profitability index of the business plan is as follows:

Calculation of profitability index
Years	Cash Outflow	Cash Inflow	PV factor	P.V.
0	-11510000.00		1.00	-11510000.00
1		3050000.00	0.87	2652173.91
2		3522500.00	0.76	2663516.07
3		4066631.00	0.66	2673875.89
4		3501865.83	0.57	2002203.16
5		4497734.35	0.50	2236168.88
				717937.91
PI= Total Cash Inflow/Initial Investment	0.062

On the basis of the profitability index calculations, it has been found that the total cash outflow of the business would be R 1,15,10,000 and the cash inflow of the business would be $ 1,22,27,938. It leads to the net profit of the business which is $ 7,17,937.91. It further explains that the profitability index of the project is 0.062 or 6.2% and briefs that the project is quite beneficial for the company (Shivaani, Jain and Yadav, 2017). If the Minenhle and Bokamosos would invest into the project then they would be able to generate huge profit from the business.

On the basis of the net present value tool, payback period, discounted payback period, average rate of return, internal rate of return, profitability index etc, it has been measured that the project is among one of the best choices for the company. The net present value calculations explain about the positive returns from the project which explains that the project must be accepted by the company.

Further, the calculations of internal rate of return of the project explains that the internal rate of return of the project is higher than the discount rate of the company and briefs that the project is quite beneficial for the company. In addition, the payback period calculations explain that the amount would be got back by the company within 3.21 years which is lesser than the life time of the machinery and thus it is a better choice for the purpose of investment (Robb and Robinson, 2014)

In addition, the discounted payback period calculations explain that the amount would be got back by the company within 4.76 years which is lesser than the life time of the machinery and thus it is a better choice for the purpose of investment. Profitability index calculations of the project further explain that the profitability index is 0.062 or 6.2% which is quite higher and explains that the project is quite beneficial for the company (Soltani, Nayebzadeh and Moeinaddin, 2014).

Conclusion:

On the basis of the study on the capital structure, it has been measured that the capital budgeting is a technique of investment proposal and appraisal which is basically a planning process that is used by the organizations and the financial manager of a business to analyze that whether the project or the business plan would offer the long term returns to the business or the investment into that business would lead to the company towards the loss.

In the report, a new business plan has been measured to evaluate the capital budgeting tools and process in better way and it has been found that the capital budgeting is an important process as it creates the measurability and the accountability of the business. the Minenhle and Bokamosos which seeks to invest into the new project in order to enhance the investment amount have evaluated the risk and return factor of the business on the basis of the capital budgeting tools so that a better decision could be made.

 The net present value calculations explain about the positive returns from the project which explains that the project must be accepted by the company.

Further, the calculations of internal rate of return of the project explains that the internal rate of return of the project is higher than the discount rate of the company and briefs that the project is quite beneficial for the company. In addition, the payback period calculations explain that the amount would be got back by the company within 3.21 years which is lesser than the life time of the machinery and thus it is a better choice for the purpose of investment

In addition, the discounted payback period calculations explain that the amount would be got back by the company within 4.76 years which is lesser than the life time of the machinery and thus it is a better choice for the purpose of investment. Profitability index calculations of the project further explain that the profitability index is 0.062 or 6.2% which is quite higher and explains that the project is quite beneficial for the company.

On the basis of this evaluation, it has been measured that the investment into the project would offer huge benefits to the Minenhle and Bokamosos and thus the project must be accepted by the owners and they must invest into the project for long term investment.

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