Explain your Budget to the County Council
PPA602 – Public Financial Management
Capital budgeting concerns the investment of funds with expectation that it generates extra remunerations or cash-flows in the future. It entails the maximization of the limited incomes to the best investment prospect that is accessible. Further, the investments of current funds focus on long-term assets. Examples of capital budgeting decisions include acquisition of another enterprise, expansion of prevailing business, replacement and transformation of assets, research and expansion programs, and the purchase of novel long-term assets. In this case, the capital budget includes acquisition of two garbage trucks, a bulldozer, three new lawn mowers, and building an activity center.
Steps and Processes in Capital budgeting
The venture will start with an idea that develops to reality. Secondly, River County should develop the ideas from the top management but should consider the notions of the lower management (Mielcarz, P. et al. 2014). Thirdly, the experts should appraise the projects to define the viability. Fourthly, it should rank the projects according to viability, utility, profitability, and desirability. Fifthly, after the ranking of the projects, the River County should form an investment committee to decide on the appropriate venture that is undertaken.
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Characteristics of Capital Budgeting
The capital budgeting decision is made by the managers or top-level directors. The projects extend beyond a year and they are considered long term in nature. Their cash flow, benefits, and returns flow in form of money over a period of time. Additional, the generated return is acceptable by creditors and owners and should exceed existing rates in the bank.
Objectives of Capital Budgeting
Capital budgeting evaluates the value of the developments and ranks them in the order of their sustainability and preference. The ranking provides a peck order that a firm can use in acquiring the assets. It also ensures effectual control over large venture. Finally, they fix primacies on expenditures so that they utilize long-term resources.
The technique used should maximize the wealth of the shareholders. Secondly, it should consider the cash flow of the projects to determine the project viability (Vecchi, V. et al. 2013). The criteria should separate the projects that assist the River County from a peak order. Supplementary, the evaluation should provide an objective that proposes a clear way of acquiring the projects.
Benefits of Capital Budgeting
The projects affect the value of the company. For example, the revenue from the garbage trucks ensures there is surge in the value of the company and shareholders wealth (Clancy, D. K. et al. 2014). The projects are expensive for example the construction of the activity center cost $650,000. So, the projects expose the company into risks. However, if implemented well, they can results to cash flow in the company.
Challenges faced in analyzing Capital Budgeting
Capital budgeting is faced with inadequate information. For example, River County acquisition plan does not reflect inadequate data. According to Gupta, D. et al. (2012), there are also uncertainties on the cash flows and cost of capital. Also, there is ambiguity on life-span of the project. Further, there is conflict in the method used for appraisal. The accounting rate of return and internal rate of return conflicts when ranking equally exclusive investments.
Methods of evaluating Capital Budgeting Techniques
The two methods of analyzing capital budgeting include the traditional method or non-discounted cash flow methods and the modern method or the discounted cash flow method. The traditional method uses accounting rate of return and payback period to evaluate capital budgeting. The modern method uses three methods to explore the viability of a project. They include net present value, profitability index, and internal rate of return.
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Analyzing the Capital Budgeting of River County
There are four assets that the River County is contemplating to acquire or create. They include two garbage truck, a bulldozer, three lawn mowers, and building an activity center. The cost per unit of garbage trucks is $150, 000, for bulldozer is $240, 000, three lawn mowers is $16, 000, and construction of an activity center includes $650,000. The expected lifetime for the two garbage trucks is 10 years, for bulldozer is 8 years, for three lawn mowers are 5 years, and 40 years for building an activity center. The total cost for the project is $ 1,670,000. The projects are ranked according to viability of the project.
The report has analyzed the steps and processes of capital budgeting. It has also investigated the characteristics, merits, and demerits of this budget. The capital budget of River County includes acquisition of two garbage trucks, a bulldozer, three new lawn mowers, and building an activity center. Further, it has explored the techniques and challenges faced in analyzing capital budgeting.
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Clancy, D. K., & Collins, D. (2014). Capital Budgeting Research and Practice: The State of the Art. Advances in Management Accounting, Emerald Group Publishing Limited, Bingley, 24, 117-161.
Gupta, D., & Mohanty, R. P. (2012). Factors affecting capital budgeting decisions: A structural equation modeling study. Indian Journal of Finance, 6(10), 18-25.
Mielcarz, P., & Mlinarič, F. (2014). The superiority of FCFF over EVA and FCFE in capital budgeting. Economic Research-Ekonomska Istraživanja, 27(1), 559-572.
Vecchi, V., & Hellowell, M. (2013). Securing a better deal from investors in public infrastructure projects: insights from capital budgeting. Public Management Review, 15(1), 109-129.
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