Capital Budgeting of Pevensey PLC Essay Example | Topics and Well Written Essays - 1750 words

Capital Budgeting of Pevensey PLC - Essay Example The present research has identified that Capital Budgeting is an important process for any organization. No organization can make good use of their money, unless they plan, decide and assess the best use of money. Good investment decisions maximize the earning potential of an organization and help boost the firm’s overall financial position and financial health. Good financial decisions are not intuitive. They require a lot of effort and financial planning. Many firms employ people with excellent financial knowledge and skills just to enhance the use of money. These people often lie at an important level of organizational hierarchy and given a title of CFO or Chief Financial Officers. Many firms, over the years, have realized the importance having people with good financial skills and have given these people more power and authority than the CEOs. As a result, these people are consulted every time a need arises for an organization to make a good financial decision. This good f inancial decision regarding the best machine is going to improve the asset earning potential for the firm and it is also going to improve the asset turnover and return on assets ratios. Pevensey PLC is a growing company. It needs to decide on the best option of a machine purchase. Currently, the company has four different options to ponder upon. It is good for the company to use financial tools of capital budgeting to appraise each of the four options before making the purchase. This will reduce the chances of a bad decision, and will put the company in a win-win direction. Hence, the company has done the right thing by consulting someone with the financial knowledge to look at the available options and deciding the best option for the purchase (Brigham & Ehrhardt 2010). This would ensure that the best purchase is made in the given budget. The best purchase will not only be the cheapest method, but the best purchase is also going to improve the overall financial position of the orga nization in the long-run. ASSESMENT METHODS: Capital budgeting is considered to be a specialist field. The methods used that are used to determine the best option to purchase are net cash flow method, discounted cash flow method, Payback period, NPV and IRR. No one method can alone be a good guide for the company for the best decisions. All of these methods have to be studied and used in congregation for giving the best answer to the company. This would ensure the best purchase is made in terms of returns, time value of money and cost of capital. The company can raise capital at a rate of 8 percent. This means that any of the option chosen must provide a return of at least 8 percent for the company to break-even. If this is not the case, the company will be losing money in real terms. It might be making money in nominal terms. Nominal and real returns are different. Nominal returns do not take into account the inflation rate and the cost of the capital to the company. Real returns t ake into account the cost of the capital that the company has to pay for obtaining the finance needed to make a purchase. The methods used in the report would help us calculate both the nominal returns and real returns to decide the best Machine to purchase that would maximize not only the firm’s cash flow, but will also the allow the firm to earn decent rates of return. The first method used to calculate the