Good Example Of Capital Budgeting Essay

Question 1: Factors affecting the risk associated with a company's capital investment decision

The risk associated with an investment decision can be increased by factors influencing project-specific risk, market risk, and international risk. Variables affecting project-specific risk are those that result in the reduction of the project’s profitability (Baker and Powell 279). These factors include investing in a project the company has no experience in, inadequate funding for the investment, and lack of appropriate skills to implement the project, among other factors. If a business invests in a project in which it lacks experience, it is likely that it will not accurately estimate the cash flows and other aspects of the project thus leading to unsound decisions.
Market-specific risks relate to economic factors such as interest rates, inflation, taxes, among other variables. An increase in interest rates will hike the cost of borrowing hence reducing the profitability of the investment (Baker and Powell 279). In addition, increase in taxes and inflation of prices of inputs will adversely affect the viability of the project. These factors affect all firms and cannot be avoided. Market-specific risks may also result from the nature of the industry in which the company operates. For instance, in an industry that experiences instability in demand for commodities, the risk associated with an investment will be increased.
International risk factors impact projects involved in international trade. If the project’s products are sold in the international market, an increase in the value of the local currency will make the products more expensive relative to the products from other countries. This will reduce the competitiveness of the project thereby increasing its risk.
In my opinion, project risk factors increase the risk associated with an investment more than market and international risk factors. This is because market and international risk factors affect all firms and projects and can be eliminated through diversification. However, project risk factors relate to the c company itself hence cannot be eliminated through diversification.

Question 2: milestone approach and its weaknesses

The milestone approach involves setting goals along the timeline from the startup to the completion of a project. During milestone planning, goals are set to be achieved by the project at predetermined dates. It assists in project monitoring and evaluation as reviews are done at the particular dates to assess whether the goals have been achieved or not. In this case, the project is sub-divided into several distinct activities that are given specific deadlines for completion. Milestone approach goes hand in hand with the critical path method of evaluating project.
The method is sometimes ineffective in that it only focuses on the activities on the critical path. Activities on the critical path determine the completion date of the entire project hence project managers concentrate their efforts and resources on these activities (Brigham and Besley 421). The disadvantage is that other activities may be ignored thus affecting the achievement of the project’s goals. The implementation of a project will be affected if non-critical activities are completely ignored even when critical activities are completed within their respective time frames.

Question 3: what economic conditions have prompted American businesses to reevaluate their traditional approach to capital investment decisions?

Tradition methods are suitable for relatively stable environments. The American economy has been dynamic in the recent years making traditional methods inappropriate for evaluating investment decisions (Brigham and Besley 390). Effective evaluation and implementation of investments require flexibility that traditional approaches do not offer.
In addition, focus has shifted from profit maximization to shareholders’ wealth maximization. Traditional approaches are based on the premise of profit maximization. Many stakeholders now focus on wealth maximization as profit maximization ignore a number of aspects such as risk, the time value of money, among other aspects.

Works cited

Baker, H. Kent, and Gary E Powell. Understanding Financial Management. New York: John Wiley & Sons, 2009. Print.
Brigham, Eugene F, and Scott Besley. Essentials Of Managerial Finance. 14th ed. Mason, OH: Cengage Learning, 2007. Print.