05 Jun Question To prepare for this Collaboration:
Question
To prepare for this Collaboration:
Read this Week’s assigned reading and reflect on how capital budgeting can help an organization to make long-term investment decisions.
1. What consequences might an organization face if it does not use capital budgeting?
2. Review the four main methods used to evaluate investment opportunities.
3. Think about the disadvantages and advantages of IRR and the other three methods, and how these could affect results.
To Complete this Collaboration:
By Sunday (Day 4), in an approximately 750-1,000 word response, address the following issues/questions:
You have just inherited a small island in the Bahamas. The island is near a favorite fishing location, and you are considering two alternative investments. First, you could construct a boat landing that provides grounds for camping. You estimate that the landing will require a £1,000 investment today and that it is expected to generate cash flows of £1,000 per year, forever. Alternatively, you could invest £10,000 today and build a restaurant and ‘beer garden’, which you believe will then generate cash flows of £4,000 per year, forever.
You cannot undertake both businesses on the island (they are mutually exclusive), and since both rely on tourists, you believe that the riskiness of each venture is identical (you may assume this to be the case and that the associated required return is 20%).
A quick calculation shows that the IRR of the first alternative is 100% and that the IRR of the second alternative is 40%. Hence, according to the IRR criterion, the first option is preferable.
1. Do you agree with the assessment?
2. Provide alternative capital budgeting evaluations of the two projects and discuss which method is the most reliable.
3. Calculate the ARR , PP , and NPV for each business.
4. Also discuss what other factors should be taken into consideration.
5. Be sure to articulate the strengths and weaknesses of each technique.
6. Base your answer on research, your readings and your own experiences.
7. Refer to Atrill and McLaney “ finance and accounting for managers” for extra help should you want to.
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