Terms in Strategic Planning and Capital Budgeting Essay

Terms in Strategic Planning and Capital Budgeting - Essay Example This formula is best used in analyzing the profitability of a project. NPV provides a value that when it turns positive project should be accepted, or rejected when the value is negative. A negative NPV produces a negative cash flows. NPV is also an ideal calculation when deciding on two projects, or comparing between them gives alternatives NPV is based on future cash estimates of the project that could be different from actual results and the difficulty of computing when the cash flows are uneven yearly. Another problem related to NPV is the use of discounting and selection of rate because different rates provide different values. Payback period is an accounting tool that is used to measure the time it will take to recover the original investment. The decision rule here is to accept the project if the payback period is less than projected.(Accounting Explained) This formula is easy to calculate and is one of the simplest tools for measuring profitability. It is also a good measure in ranking projects that would return money easily. For instance, the payback period of a project requiring $100 million dollars and is expected to generate a $5 million return for 5 years: Since expected cash flows are estimates, it is possible that there is a certainty that what is projected will not be the probable result. It could also suggest that there would be an uneven distribution of expected cash flow. This is due perhaps that changes in business are continuous and substantial. We should remember that in business, the product, the consumer, the competition, and the workforce today are very much different from ten years ago, and we cannot predict the outcome of the economy. In addition, this model does not take into account cash flows that occur after payback period is reached.