Capital Budgeting Essay

Capital Budgeting Essay

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Capital Budgeting
The city engineers presented city council members with two projects that require large capital outlays. However, the economic downturn makes implementation of both projects impossible with current budget restraints. Therefore, the city council decided to conduct a cost benefit analysis to determine the most cost effective project. While neither project met all the requirements, data analysis determined that Option B was the best choice. However, city engineers pushed back stating that both projects are vital to the city. Consequently, it was necessary to consider an alternative solution. The proposal below provides a detailed explanation of all options including an alternative solution.
Explanation: Option A and Option B
The city has required a return of 12 percent and a critical acceptance level of 2.75 years. While neither project meets all critical, Option B does meet the internal rate of return. In determining the payback period, the formula used included total capital costs minus benefits. The total capital cost is $-3,500,000.00 for Option A minus benefits made the payback period 7.475 years. While the total capital costs for Option B is $-3,000,000.00, minus benefits making the payback period 5.0 years for Option B. Additionally, the internal rate of return calculation includes the capital costs and benefits. For Option A, capital cost is $-3,500,000.00 with total benefits equaled to $5,220,000.00 created an internal rate of return of eight percent. However, Option B has capital cost of $-3,000,000.00 and total benefits of $6,300,000.00 generated an internal rate of return of nineteen percent. Additionally, to calculate the net present value it was necessary to include years' two and thre...


... middle of paper ...


... In closing, the best solution for the current budgetary limits is the alternative solution.



References
Boardman, C. M., Reinhart, W. J., & Celc, S. E. (1982). The role of the payback period in the theory and application of duration to capital budgeting. Journal of Business Finance & Accounting, 9(4), 511-522.
Hartman, J. C., & Schafrick, I. C. (2004). The relevant internal rate of return. The Engineering Economist: A Journal Devoted to the Problems of Capital Investment, 49(2), 139-158. doi:10.1080/00137910490453419
Mikesell, J. L. (2010). Fiscal administration: Analysis and applications for the public sector (8th ed.: 2010 custom edition). Mason, OH: Cengage Learning.
Rangarajan, C., & Mampilly, P. (1971). Net present value versus internal rate of return. Economic and Political Weekly, 6(48), M153-M154. Retrieved from http://www.jstor.org/stable/4382801

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