Capital budgeting conducting every year in purpose to have a project presentation in order to asking money to execute the project. Capital Budgeting is the process by which the firm decides which long-term investments to make.
They are a category on capital investment, are:
– Growth Investment
– Sustaining Investment
For this blog, capital budgeting process will focus on Sustaining Investment since this capital category is the most category that proposed by sponsor.
For sustaining investment at capital budgeting, will use Discounted Cash Flow (DCF) technique.
Discounted Cash Flow is what someone is willing to pay today in order to receive the anticipated cash flow in future years. DCF means converting future earnings today’s money.
DCF can be an important factor when evaluating or comparing investments, proposed actions, or purchases. When discounted cash flow events in a cash flow stream are added together, the result is called the Net Present Value (NPV).
However, NPV method sometime is not consistently use during analysis of business case when capital budgeting process conducting. The NPV calculation required especially for sustaining project with Betterment Type, which is delivering the financial evaluation to company if we want to spend the money for medium and/or long term investment.
Figure 1 Interrelationship Diagraph
From data above, we have 2 main problems why NPV can’t consistently used as main supporting document when business case presented for capital budgeting process, are:
1. NPV number not represent the business case proposed
Some of sponsor attached their financial analysis, but the number of calculation is not representing the main purpose of investment required. The impact is, capital budgeting proposed can’t release.
2. NPV number can’t calculated well
Most of sponsor attached their financial evaluation, but the number of NPV is wrong due to lack of data and the impact is, capital budgeting committee hard to find the solid justification from their financial evaluation.
Here some solution to be following up to ensure NPV calculation consistently used and deliver the correct number.
Figure 2 Tree diagram
Understanding of how important NPV calculated well in order to support the justification of business case is the important thing that sponsor has to aware and willing to change their paradigm to ensure NPV delivering the correct number and can used by Capital Committee prior releasing the budget to execute the project proposed.
Conducting training to sponsor and/or engineer is the key to ensure all area understand on how NPV calculated and used. Socialization and Project Management Road Show is the sustaining program to support this.
- Brassard, M and Ritter, D (2010), The Memory Jogger (2nd Edition),Canada, GOAL/QPC
- Value Based Management.net (2012). Discounted Cash Flow – DCF. Retrieved from http://www.valuebasedmanagement.net/methods_dcf.html
- Schmidt,Marty (2012).Discounted cash flow (DCF) / NPV / Time value of money concept. Retrieved from http://www.solutionmatrix.com/discounted-cash-flow.html