Budgeting Decisions of the Capital

Financial Study and Appraisal

Before making any business investment, it is critical for the company’s best interests to undertake extensive financial study on the proposed investment with the support of the personnel (Braun et al., 2014). The appraisal employs both financial and nonfinancial information regarding the investment. The audited financial statements are the most important information to obtain from the target organization. According to Gitman, Juchau, and Flanagan (2015), the target company should be willing to provide audited financial accounts for the previous five years in order for the accounting department to evaluate the project’s profitability. Another critical piece of information to consider is the company’s potential purchase price. The amount will act as the initial capital outlay for the acquisition, which will assist the company with the help of the financial officer to conduct various capital budgeting procedures, by forecasting possible cash flows to determine the net profit value after the acquisition.

Market Price and Synergies

The company’s market price should be inclusive of the value of the targeted firm’s assets; both fixed and currents, the target company’s liabilities, such as debts, account payables, and any other significant financial information that will aid in identifying the fair market price of the company. Again, there is the need to evaluate the potential synergies, which will arise out of this acquisition. The focus will be based on the reduction in the operational costs, as a result of the higher value chain, management strength, greater market control, among others. Finally, the staffs should evaluate the nonfinancial aspect of the acquisition, which might have a substantial financial impact on the investment (Weygandt, Kimmel & Kieso, 2015). For instance, does the company have the potential of generating more revenue due to nonfinancial reasons such as the market share, the consumers’ perceptions, and the likes.

Decision-Making Process

According to Gitman, Juchau & Flanagan (2015), the decision-making process should be as a result of acquiring and evaluating the critical investment information; that is the financial and non-financial information. At this step, the company with the assistance of the staffs should conduct a substantial capital budgeting evaluation by gathering all the pertinent financial data to analyze the feasibility of the investment. The assessment will be based on the incremental cash flow that might result from the acquisition of the target company. The analysis should incorporate the forecasting of the possible financial cash flows in the form of revenue and the additional expenses that will show whether the investment will improve the overall performance of the enterprise. It is essential to apply all the possible capital budgeting techniques such as the payback period method, the NPV, the average rate of return, profitability index, among others. The procedures will enable the firm to identify the break-even points, and the possible net profit for the investment over a given fiscal period (Gitman, Juchau & Flanagan, 2015). After the evaluation of the financial significance of the investment, the company can come up with the decision of acquiring or not acquiring the target firm. For this situation, the accept/reject decision will be based on the capital budgeting evaluation results, but not through the guesswork.

Relevance of Future Costs

Not all the future costs that are relevant to decision making for investment. However, some prospective expenses like the avoidable costs are pertinent to the unimplemented investments. Contrary, some committed costs; those that cannot be avoided are irrelevant in decision making as they will still be incurred irrespective of the business decision considered (Braun et al., 2014). The future costs are the expenses that shall be incurred in the all managerial alternative considered; therefore, they are irrelevant as they are the same in all the other options.

Capital Budgeting Decisions

The capital budgeting decisions fall into two categories, that is the screening decisions and the preference decisions. As stated by Weygandt, Kimmel & Kieso (2015), the screening decisions focus/relate on whether the proposed investment meets or passes the present hurdle. For instance, a company may set a standard of accepting the projects that promise to give a return of maybe 25% of the initial capital outlay. It means that the set minimum hurdle is the required rate of return, which an investment must yield to be acceptable or invested on and if it fails, it automatically gets declined. For the preference decisions, the firms concentrate on selecting among several competing courses of actions (Weygandt, Kimmel & Kieso, 2015). A typical example is where an organization has a variety of different machines that can replace an existing one, which may be ineffective or not be functioning. For the firm to decide on purchasing a specific device, it will have to make a preference decision.

The Case of the EEC

In the case of the EEC, the company should make use of the screening decisions. The acquiring of an enterprise does not include a variety of them; instead, the company has only one approach from one of the largest suppliers. It means the firm requires applying various capital budgeting procedures through the use of the set RRR to evaluate and see whether the investment is worth taking or rejecting. For instance, the company can set a hurdle of 15% RRR for the investment, where the return must exceed the break-even point with the same or more percentage return.

References

Braun, K. W., Tietz, W. M., Harrison, W. T., Bamber, L. S., & Horngren, C. T. (2014). Managerial accounting. Pearson.

Gitman, L. J., Juchau, R., & Flanagan, J. (2015). Principles of managerial finance. Pearson Higher Education AU.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting. John Wiley & Sons.