Capital budgeting refers to a method that predicts the long-term financial viability of a capital project by putting more emphasis on cash flows rather than earnings. In addition, the technique calls for determining cash flows, both incoming and outgoing (Alles, 2020). On the other hand, the price-to-earnings ratio and return on assets are used in the financial performance assessment method to assess the organization’s overall health and performance.
Notable capital budgeting analysis techniques are vital, and I will use some of them to analyze the economic viability of my proposed investment in fixed assets. They include the payback period, the discounted payment period, the net present value, the profitability index, the internal rate of return, and the modified internal rate of return.
- Net Present Value: I will calculate this technique by determining the current worth of revenues and expenses. By employing this capital budgeting approach, my corporation will determine whether or not this project will provide favorable returns for the business. For example, I will participate in a venture only if the ratio between the current value of income and expenditure is positive. Therefore, this strategy yields favorable results for my organization.
- Internal Rate of Return (IRR): I will use this methodology to determine if my proposal should be accepted; therefore, if the IRR is more than the firm’s lending rate, my business should approve the initiative; otherwise, it should reject it. It will help my corporation to determine if it will engage in a given project through this strategy.
We will now compare instances where other students have demonstrated the payback period method for capital budgeting. In the payback period, another tool of capital budgeting, the time is used to determine how many years the firm will receive cash flows equivalent to its cash outlay. Moreover, both capital budgeting approaches are applied to determine whether a corporation will invest in a specific project. At the same time, they are different in that the payback period technique omits the discounting factor and current values when calculating the outcome. They disregard the idea of the time’s worth of money. Hence, the payback period strategy’s primary downside is less desirable.
Financial Performance Evaluation
ROA and PE are essential financial measures to analyze a company’s financial health. Return on assets is a performance ratio that indicates the outcome of a corporation or business’s activities (Awalakki & H.N, 2021). ROA is a rate of return ratio using the following formula: ROA = net income/average total assets. This profitability metric has total assets as its foundation, indicating how a corporation utilizes its assets and resources.
PE ratio is an evaluation measure that illustrates how a company’s stock is valued in the capital market. Notably, a stock’s market value represents the combined effect of return and risk; thus, valuation measurements such as PE ratios are crucial. PE ratio = market price per share / per-share earnings. The PE ratio represents a corporation’s development potential, hazard attributes, investor approach, company identity, and level of solvency.
Basically, Emerson is a firm that I am acquainted with. In this way, as of July 2022, the company’s ROA is 10.85 percent, and its PE is 17.61 (Emerson Electric ROA, 2022). These measures allow me to assess Emerson’s financial health to some degree. Given Emerson’s function, the company’s ROA shows that it earns $2.87 billion in net income, which is somewhat respectable (Emerson Electric ROA, 2022). The business’s PE ratio of 17.61 suggests that investors and the market are optimistic about Emerson’s growth prospects (Emerson Electric ROA, 2022). As a result, they are valuing the company at a premium compared to its profits.
In a bid for my company to succeed, I will implement the capital budgeting technique and financial performance evaluation. They will be fundamental capital budgeting requires calculating incoming and exiting cash flows, such as net present value and internal rate of return. On the other hand, financial performance evaluation, return on assets, and price-to-earnings are crucial financial metrics for analyzing a company’s financial health. Return on assets is a performance ratio indicating the results of a company or organization’s actions.
Alles, L., Jayathilaka, R., Kumari, N., Malalathunga, T., Obeyesekera, H., & Sharmila, S. (2020). An investigation of the usage of capital budgeting techniques by small and medium enterprises. Quality & Quantity, 55(3), 993–1006. Web.
Awalakki, M., & HN, D. (2021). Impact of financial performance ratios on stock returns–a study with reference to national stock exchange. Int. J. of Aquatic Science, 12(3), 2151-2167. Web.
Emerson Electric ROA 2010-2022 | EMR. (2022). Macrotrends.net. Web.