Capital budgeting is an integral part in management. Hence, organizations such as Costco Wholesale must pay attention to certain factors as captured in the paper. The capital budgeting exercise entails planning a feasible implementation of a project for the purposes of investment. In the subject case, the assignment for discussion regards implementation of a new computer network system that reduces the time taken between placing an order and making a delivery in Costco Wholesale. The costs for the project are estimated to be 10% of the previous year’s profits.
The following factors are critical towards determination of relevance to undertake an investment project. The first factor is the return to be earned from an investment. In business, the main objective is to make profits. Various investment appraisal techniques would be used to determine the viability of a project. A positive net present value or net worth of a project would indicate earning of a profit while a negative result would imply incurring of losses in case the project is implemented. The amount to be earned as a return from investment remains the most important determinant towards the implementation of capital projects.
The time to be spent to implement a project is another determinant. Projects that reasonably take short time to implement would be favored over those that take long periods. Undertaking of projects within a less period allows the management to foresee any extra costs and cater for them. However, those that consume time and take long periods into the future become difficult to predict. Such a situation leads to an expense of extra costs by an organization, which means these projects present a challenge.
The above factors are important in the capital budgeting process. As was already pointed out, the return on investment is the most important determinant. The worth of a new project dictates whether an investment should be undertaken or shelved. A project that guarantees the highest return on investment should be preferred against those that promise low returns. Therefore, it is important every company understands the amount of return to be earned.
The appropriate and sound criteria must be devised to determine the ranking of capital budgeting decisions. The most important criteria are based on the results of the return on investment to be earned. Those projects that would earn high returns would be preferred for implementation as argued by Varshney. Some criteria are more significant than others are. For instance, in the subject case, the time factor may not be of great importance. A project may take a very short period to implement, but it does not promise any notable income to a company. Such criteria may not influence investment decisions. Nonetheless, the time taken to carry out a project should be reasonable.
To calculate the return on investment, the total costs and total income to be earned from the implementation of a project must be computed. The average costs to be incurred annually compared to the average profit to be earned annually are useful in indicating whether a return is earned or a loss incurred. The results from the ratio between the average annual profit and average annual costs expressed in a percentage represent the return on investment. Alternatively, the total profit compared to the total costs represents the return on investment. A capital budgeting process should only fund projects that guarantee a return to the company.
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