The Capital Budgeting simulation asks the user to decide between two mutually exclusive capital investment proposals. In the following discussion, an analysis of the risks associated with the investment decision will be presented. Furthermore, a mitigation plan for each risk discussed will be included in the following discussion. In what long-lived assets should the firm invest (Ross 2005)? This question concerns the left-hand side of the balance sheet (Ross 2005). Of course, the type and proportions of assets the firm needs tend to be set by the nature of business (Ross 2005). We use the terms capital budgeting and capital expenditures to describe the process of making and managing expenditures on long-lived assets (Ross 2005).
In this simulation, measures such as Net Present Value (NPV), Internal Rate of Return (IRR), and Profitability Index (PI) shall be used to compare two mutually exclusive capital investment proposals. Before one arrives at the final NPV, IRR, and PI values for the proposals, one would have to analyze their cash flow statements. One does this by examining the assumptions made while predicting sales, price, and marketing cost for the proposals; checking whether the capital expenditure schedules planned are optimal; accounting for hidden cash flows; accomodating for the risks inherent in the proposals; leveling the cash flow streams of the two proposals using annuity calculation (UoP 2008) . Finally, one chooses the proposal with the higher NPV, IRR, and PI values.
Net Present Value
Shareholders of organizations would like to invest in projects that are worth more than they cost (UoP 2008). The difference between the project’s value and cost is called the Net Present Value (NPV). For this simulation, managers accept all projects with a positive NPV. But if it is necessary to choose between two mutually exclusive projects, one should choose the project with the higher NPV.
Internal Rate of Return