Valuation Function in Capital Budgeting
The unit lesson and the textbook readings for this unit list several project valuation methods. Choose three project valuation methods, and write an essay that explains each of the methods. Specifically, your essay should cover the following topics:
- Include an introduction that explains the overall function of valuation methods in capital budgeting and why capital budgeting is so important.
- Explain the benefits and drawbacks of each valuation method, and describe whether the method is more beneficial in analyzing for-profit or nonprofit organizations.
- For each valuation method, give a scenario where the method chosen would be beneficial in making a decision between different projects. If additional valuation methods would be beneficial in making a decision between the projects, explain why.
- Conclude with an analysis of the effects of inflation and healthcare trends and how these should be factored into capital budgeting decisions.
Your essay must be at least two pages in length, double-spaced. You are required to use at least three outside sources
Project Valuation
Payback method: This is a project valuation method that encourages front-loaded cash flows by favoring projects on the basis of investment recovery time. It uses discounted cash flows (DCF). This project valuation method does not consider what happens once the payback is achieved or the TVM. Accounting rate of return (ARR) method: ARR is a project valuation method that compares the cash returns to an ARR using cost of capital, past company data, and/or the uncertainty of the project (Wilkinson, 2018). The calculation is average annual income / average investment (or initial investment if the whole investment was at the beginning of the period). Net present value (NPV) method: NPV is a project valuation method using the present value of net cash outflows and net cash inflows. The NPV method discounts future cash inflows and future cash outflows based on the minimally accepted cost of capital, also known as the hurdle rate, which is generally the weighted average cost of capital (WACC) that is risk adjusted. Any answer that is $0 or greater than $0 is considered a profitable project where the organization recovered its costs. Internal rate of return (IRR) method: Based on TVM, IRR calculates the interest rate where the PV cash outflows are equal to the PV of cash inflows. The IRR is compared to the hurdle rate in determining viability for the project (Wilkinson, 2018).