Final answer:
Capital budgeting involves analyzing and evaluating investment projects, using financial tools such as payback period, NPV, IRR, and profitability index. The most common method used by financiers to evaluate capital budgeting projects is the net present value (NPV) method. It is important to consider the social effects of investment decisions to ensure sustainability and responsible business practices.
Step-by-step explanation:
a. What is meant by capital budgeting?
Capital budgeting is the process of analyzing and evaluating investment projects to determine which ones are worth pursuing. It involves estimating the cash flows associated with the projects, considering the time value of money, and using various financial tools to make informed decisions.
b. What are the different financial tools used in capital budgeting for investment decision making? Explain and present simple numerical examples.
The different financial tools used in capital budgeting include payback period, net present value (NPV), internal rate of return (IRR), and profitability index. The payback period calculates the time it takes to recover the initial investment, while NPV and IRR consider the time value of money and provide a measure of the project's profitability. The profitability index compares the present value of the project's cash inflows to the present value of its cash outflows. For example, if a project has an initial investment of $10,000 and is expected to generate cash inflows of $2,000 per year for 5 years, the payback period would be 5 years, the NPV and IRR would be calculated based on the cash flows and discount rate, and the profitability index would be calculated by dividing the present value of the cash inflows by the present value of the cash outflows.
c. What is the quintessential method that financiers most often apply to evaluate capital budgeting projects? Explain your answer.
The quintessential method that financiers most often apply to evaluate capital budgeting projects is the net present value (NPV) method. NPV calculates the present value of a project's estimated cash inflows and outflows, taking into account the time value of money. If the NPV is positive, it indicates that the project is expected to generate more cash inflows than outflows and is therefore considered a good investment.
d. Why is it so important to make investment decisions considering the social effects, above the financial viabilities that generate high returns?
It is important to consider the social effects of investment decisions because they impact society as a whole. While financial viability is important for businesses to generate high returns, it should not come at the expense of negative social impacts, such as environmental damage or harm to communities. By considering the social effects, businesses can make more sustainable and responsible investment decisions that benefit both the company and society.