Introduction

The methods of capital budgeting evaluation help in determining the economic value of projects that will be undertaken by large firms.  These methods focus on the present value and estimation of future value to determine whether to retain of expand the project being undertaken.

Discussion

Internal Rate of return involves a discount rate that will give zero cash flows for a given project. Given that future cash flows are not guaranteed, the method adds a risk premium to such risks to take into account the effect of fluctuation in interest and inflation rates.  The Weighted Average Cost of Capital is a method that measures the cost involved in obtaining funds for funding a project, which is the amount paid debtors above what they invested in the project (Crundwell, 2008).  The cost vs. the returns determines whether the project is good.

The Minimum Acceptable Rate of Return determines whether the firm’s management will accept or reject a given project. In this case, if the Internal Rate of Return is more than the MARR, the projects will probably approval the investment of funds into such a project. The difference between IRR and MRR  is important because different projects will have distinct characteristics , and the management will have determine the one with higher cash flows , its uncertainty and the length of period  that returns will be realized in future (Crundwell, 2008). MARR as an opportunity cost compares projects so that the cost of maintenance and expansion are compared to determine the optimum selection.

Conclusion

Evaluation of capital budgeting is aimed at make the right decision on whether a project should be approved or not. The IRR and MARR as an opportunity cost are important aspects in comparing projects and choosing the most appropriate.

References

Crundwell, F. K. (2008). Finance for Engineers: Evaluation and Funding of Capital Projects. 265-269