Respond to two or more of your colleagues’ posts in one or more of the following ways: ( Respond to each Colleague 150 words or more)
• Ask a clarifying question about your colleague’s example and/or analysis.
• Provide a different perspective on which method your colleague, as a manager, could use to make the decision.
• Offer an insight you gained from your colleague’s analysis of why they would choose one particular method over the others.
Return to this Discussion in a few days to read the responses to your initial posting. Note what you have learned or any insights you have gained as a result of the comments your colleagues made.
1st Colleague to respond to:
Capital Budget Methodologies
Element 1: Capital Budgeting Methods
The selected organization for this analogy is the engineering firm of my last employment prior to my medical career pursuit. Utilized during this employment are capital budgeting methods for the establishment and determination of economic feasibility of capital investments. Methods utilized include (a) modified internal rate of return, (b) internal rate of return, (c) profitability index, (d) net present value, (e) discounted payment period, and (f) payback period (Hofstrand, 2013; Kengatharan, 2016).
The internal rate of return (IRR) for example was utilized in the evaluation of what project was worth pursuing by the organization. The IRR rule applied emphasizes that the project should be pursued if the IRR exceeds the minimum required return rate, known as the hurdle rate. Utilizing IRR aids decision making of pursuing or not pursuing a project. The IRR is explicated as the discount rate that institutes the project’s net present value to zero, ranking project attractiveness, such that IRR should be higher than the project cost of capital (Hofstrand, 2013).
Element 1b: Choosing a Capital Budgeting Method
Of the capital budgeting methods listed above, I will still utilize the IRR to rank project attractiveness, making organizational recommendation of which project to embark on. The procedures utilized encompasses; (a) the identification of organizational objectives for the long term, (b) the identification of projects that aligns with achieving these long term organizational objectives, (c) identification, analysis, and estimation of the apposite cash-flow that aligns with these long term organizational objectives, (d) establishment and determination of the financial feasibility of these projects, (e) deciding on which project to recommend its implementation, and (f) implement and monitor implementation.
Element 1c: Rationale for Choosing a Capital Budgeting Method
The most imperative rationale for choosing the IRR other than the simplicity to understand the concepts and formula, stems from its taking the time value of money into account. IRR facilitates the understanding of the investor to consider and get a snapshot of the potential return on investment of the project. IRR facilitates the calculation, measurement, and provision of a simple means for the comparison of project worth of multiple projects under consideration. This facilitates a managerial dashboard of capital projects that offers the best return. IRR needs no complex or critical computational skills or methods.
It is also imperative to cite the disadvantages of IRR. IRR does not consider the project size in the evaluation. IRR ignores the future costs by only considering cash flow projections generated by capital injections. IRR also ignores the reinvestment rates. Although, it allows the calculation of future cash flows, it makes an obvious assumption that those cash flows can be reinvested at the same rate as IRR (Lanctot, 2019).