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Capital Budgeting Methods for Corporate Project Selection

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Capital Budgeting Methods for Corporate Project Selection
Capital Budgeting Methods for Corporate Project Selection In a 2001 Graham and Harvey survey of 392 chief financial officers (CFOs) asked “how frequently they used different capital budgeting methods?” Approximately 75% of the CFOs replied that they use net present value (NPV) or Internal Rate of Return (IRR) always or almost always (Smart, Megginson & Gitman, 2004, pg. 251). Projects are viewed as capital investments in the corporate world, and as such, are evaluated closely for their possible financial impacts on the “bottom line” due to their higher risk of failure. Capital investments are those that are considered long-term investments such as manufacturing plants, R&D, equipment, marketing campaign, etc., and capital budgeting is “the process of identifying which of these investment projects a firm should undertake” (Smart, Megginson & Gitman, 2004, pg. 227). According to Smart, Megginson & Gitman, there are three steps in the capital budgeting process: * Identifying potential investments * Analyzing the set of investment opportunities, identifying those that will create shareholder value, and perhaps prioritizing them * Implementing and Monitoring the investment projects selected
This paper will focus on step two, and will discuss the strengths and weaknesses of the four most common methods that are utilized for evaluating, selecting and prioritizing projects in the corporate world. Net Present Value (NPV), Internal Rate of Return (IRR), Straight/Discounted Payback Period and Profitability Index are the four of the most come methods used during step 2 of the capital budgeting process. Four fictional potential capital investments will be used to illustrate how the different methods can affect project selection for a portfolio.
THEME PARK CAPITAL INVESTMENTS A theme park senior executive management team had four capital projects presented during the last capital budget meeting. The projects are a $250M park expansion,


References: Meredith, J. R., & Mantel, S. J. (2008). Project management, a managerial approach. (7 ed.). United States of America: Wiley. Pennypacker, J. S., & Dye, L. D. (2002). Managing multiple projects. New York, NY: Marcel Dekker, Inc. Smart, S. B., Megginson, W. L., & Gitman, L. J. (2004). Corporate finance. Mason, Ohio: Thomson/South-Western.
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