Capital Budgeting MBA Project Report
Preface
Capital budgeting is primarily concerned with how a firm makes decisions on sizable investments in long-lived projects to achieve the firm’s overall goal. This is the decision area of financial management that establishes criteria for investing resources in long-term real assets.Investment decisions (on sizable long-term projects) today will determine the firm’s strategic position many years hence, and fix the future course of the firm. These investments will have a considerable impact on the firm’s future cash flows and the risk associated with those cash flows. Capital budgeting decisions have a long-range impact on the firm’s performance and they are critical to the firm’s success or failure.One of the most crucial and complex stages in the capital budgeting decision process is the financial or economic evaluation of the investment proposals. This ‘project analysis’ is the focus of this book. Project analysis usually involves the identification of relevant cash flows, their forecasting, risk analysis, and the application of project evaluation concepts, techniques and criteria to assess whether the proposed projects are likely to add value to the firm. When the project choice is subject to resource constraints, mathematical programming techniques such as linear programming are employed to select the feasible optimal combination of projects.
Motivation for the book
The writing of this book was motivated by the lack of a suitable capital budgeting textbook with the following desirable features and coverage:
• Analysis and applications based on sound conceptual and theoretical foundations with
pedagogical tools appropriate for capital budgeting
• Cash flow forecasting
• Project choice under resource constraints
• Comprehensive illustrations of concepts, methods and approaches for project analysis
under uncertainty (or risk), with applications to different industries
• Preparing the reader for actual project analysis in the real world which involves volu-
minous, tedious, complex and repetitive computations and relies heavily on computer
The book bridges this gap in the market by including these features and areas of coverage.
Distinctive features and areas of coverage
Distinctive features include:
• Practical approach with applications based on sound and appropriate concepts and theory
• Concepts, techniques and applications are illustrated by worked examples, tables and
charts
• Worked examples are extensively supported with live Excel workbooks easily accessible
on the Web
• Use of pedagogical tools – such as Excel spreadsheet calculations accessible on the
World Wide Web – to help the users of the book grasp important and difficult concepts
and calculations, and make them clear, useful, attractive and sometimes fun by the use of
technology (computer packages)
• Complex and difficult topics are explained intuitively with tableaux rather than in terms
of algebra.
Areas of coverage include:
• Quantitative and qualitative techniques for cash flow forecasting
• Application of mathematical programming techniques such as linear programming for
decision support when the project choice is subject to resource constraints
• Sensitivity and break-even analysis and simulation- with application stovarious industries
such as the computer, airline, forestry and property industries, each of which has its unique
characteristics
• As well as the standard industrial investment examples, the exotic and environmentally
sensitive area of forestry investment and the increasingly demanding area of property
investment are analysed with examples and case studies. The intricacies of investment
across international borders are also discussed.
All of this material is reinforced with some challenging end-of-chapter review questions. Solutions to all the calculation questions are fully worked on Excel spreadsheets and are available on the Web.
Organization of the book
This book follows a natural progression from the development of basic concepts, principles and techniques to the application of them in increasingly complex and real-world situations. Identification and estimation of cash flows are important initial steps in project analysis and are dealt with in Chapters 2 to 4. Once the cash flows have been estimated, investment pro- posals are subjected to project evaluation techniques. The application of these techniques involves financial mathematics (Chapter 5). Chapter 6 uses the cash flow concepts andthe formulae (from Chapters 2 and 5) to evaluate case study projects using several project evaluation criteria such as net present value (NPV), internal rate of return (IRR) and payback period, and demonstrates the versatility of the NPV criterion. This basic model is then ex- panded to deal with risk (oruncertainty of cash flows) through the use of the risk-adjusted dis- count rate and certainty equivalent methods (Chapter 7), sensitivity and break-even analyses (Chapter 8) and risk simulation methods (Chapter 9). These concepts and methods are then applied in a case study involving the evaluation of a forestry investment in Chapter 10. Re- source constraints on the capital budgeting decision are considered in Chapters 11 and 12 by introducing the basics of linear programming (LP), applying the LP technique for selection of the optimal project portfolios and presenting extensions to the LP technique which make the approach more versatile. A number of special topics in capital budgeting are covered towards the end of the book. They include forestry investment analysis (Chapter 13), prop- erty investment analysis (Chapters 14 and 15) and evaluation of international investments (Chapter 16).
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