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SLU 302 Business Capital Investments Discussion
Part (1)
Some types of capital investments have associated cash flows that are very difficult to estimate, while other types of capital investments have associated cash flows that are very easy to estimate. Name two capital investments from your chosen publicly traded entity, one that has associated cash flows that are easy to estimate and one that has associated cash flows that are difficult to estimate. Explain how these two types of investments differ and why the associated cash flows are easier or more difficult to estimate.
(Part 2a)
Making judgments about capital investments is one of the most prominent issues managers encounter, according to William J (2020).
The phrase “capital investment” usually refers to money spent on acquiring plant assets, creating new product lines, or acquiring subsidiary businesses.
Once the money has been committed, such decisions are challenging, if not impossible, to reverse. They commit financial resources for extended periods. Therefore, businesses stand to gain (or lose) for many years from wise capital investments.
Capital budgeting is the process of analyzing and ranking potential capital investment possibilities. Estimates of a future operating performance play a significant role in capital budgeting. These estimations frequently have a high level of uncertainty; thus, managers should analyze them carefully. Numerous non-financial considerations are also considered (William, J, 2020, p. 1126).
There is no set budget for capital investment.
While large-scale projects in capital-intensive industries like mining, utilities, and infrastructure may cost hundreds of millions, a startup may only need less than $100,000 in initial money.
A company’s decision to invest is part of a long-term growth plan. A business plans and conducts capital expenditures to assure future growth.
Increasing operating capacity, market share, and generating more revenue are specific goals of capital investments.
For the same goals, the company may invest money in the form of stock ownership in the complementary business operations of another business. (What Is Capital Investment? n.d.)
Microsoft is often recognized as a highly profitable company.
Microsoft Corporation develops and maintains the software, services, hardware, and other products.
Its three business categories are productivity and corporate processes, more innovative clouds, and personal PCs.
The Productivity and Business Processes segment includes the company’s portfolio of productivity, communication, information services, and related devices and platforms.
The “Intelligent Cloud” segment refers to the company’s public, private, and hybrid cloud technologies and services that may be used to power modern enterprises.
More Personal Computing includes products and services for end-users, programmers, and IT professionals across all platforms. OS systems, server applications, business solution apps, server apps, desktop and server administration tools, software development tools, video games, personal computers, tablets, gaming and entertainment consoles, other intelligent devices, and matching accessories are also sold by the company.
The company is committed to pursuing its goals in Research & Development, which currently include reimagining productivity and business processes, constructing an intelligent cloud platform, and developing more personal computing technology.
The information on a company’s statement of cash flows might provide insight into the company’s cash expenditures. The cash outflows and cash inflows of a business are depicted on its statement of cash flows (cash inflows). In its cash flow statement, a business will indicate how much money it receives from its ongoing operations and outside investments and how much it spends on business activities and assets over a particular quarter. These comprise cash flows from operating as well as investing and financing activities.
In this case, Microsoft’s cash flow is derived from operating activities, which are easy to estimate; the amount of money the company generates via its continuous, routine business activities, such as manufacturing and selling products or providing consumer services. (Definition of Cash Flow from Operating Activities (CFO), n.d.) On the other hand, technology is more challenging to estimate due to its ongoing evolution. Therefore, the company could underestimate or overestimate, which can be detrimental to the company’s success.
This is where Capital budgeting comes into place. Businesses implement internal controls for the capital budgeting procedure to prevent unduly optimistic or pessimistic estimations and aggregation errors. Numerous businesses employ routing forms requiring all senior-level managers to sign off on significant capital budgeting projects. The knowledge of the financial department is utilized to analyze and execute evaluations about the correctness of estimates. Typically, the board of directors must approve the most significant strategic capital investments (William, J, 2020, p. 1135).
References:
10 most profitable companies in the world. (n.d.). Investopedia. Retrieved June 26, 2022, from https://www.investopedia.com/the-world-s-10-most-profitable-companies-4694526
Cash flow from operating activities (CFO) definition. (n.d.). Investopedia. Retrieved June 28, 2022, from https://www.investopedia.com/terms/c/cash-flow-from-operating-activities.asp
Microsoft Corp. (Nasdaq: MSFT)| revenues. (n.d.). Stock Analysis on Net. Retrieved June 28, 2022, from https://www.stock-analysis-on.net/NASDAQ/Company/Microsoft-Corp/Analysis/Revenues
What is Capital investment? (n.d.). Investopedia. Retrieved June 26, 2022, from https://www.investopedia.com/terms/c/capital-investment.asp
Williams, J. (2020). Financial & Managerial Accounting (19th Edition). McGraw-Hill Higher Education (US). https://reader2.yuzu.com/books/9781260706178
Part (2b) This is a discussion response so please lets add to the discussion.
The most commonly used methods for capital budgeting are the payback period, the net present value, and an internal rate of return evaluation.
Payback Period. The payback period method is popular because it is easy to calculate. The payback period estimates how long it takes to get the original investment back. Net Present Value. Unlike the payback method, the net present value approach does consider the time value of money for as long as the projects generate cash flow. The net present value method uses the investor’s required rate of return to calculate the present value of future cash flow from the project. Internal Rate of Return.
The internal rate of return method is a simpler variation of the net present value method. The internal rate of return method uses a discount rate that equals zero present value of future cash flows. This approach gives a way of comparing the attractiveness of several projects. (Woodruff, 2019).
For example, companies like Apple Inc. Apple Inc. can capitalize on Software development over the software running successfully in operations. On the other hand, a failed project related to software development is expensed. Thus, before capitalization, a project is required to be finalized. Software development in its product will define the success of their products like iPhone, iPad, macs, etc. Therefore, the investment (outflow) made in software can be estimated more quickly than the cash inflow generated from such investments in the future.
Apple’s financial statement states that capitalized costs relating to the internal-use software are amortized over the asset’s estimated useful life on a straight-line basis. Therefore, investment in the land, building, and property by any company can quickly provide the benefited gains in terms of future inflows by estimating the revenue generated by that building or store, the customer’s footfall in the store, or the number of customers visiting the store, profit generated in comparison to the targeted output by that building and many more. For example, investments in land and building of Apple Inc. increased from $13,587 million in 2017 to $16,216 million in 2018.
Thus, the benefits generated by making the capital investment into such properties can be determined easily compared to estimating the cash inflows by investing in intellectual property, software development, etc. (www.investopedia.com). Likewise, the cash inflows by investing in such property can be determined by the revenue generated from that building or store, products sold, production, customer footfall, etc. Thus, the company can judge whether the land is providing benefits in terms of output and profits.
References
Apple Inc. (NASDAQ:AAPL): Financial Analysis and Stock Valuation. Stock Analysis on Net. (n.d.). Retrieved June 28, 2022, from https://www.stock-analysis-on.net/NASDAQ/Company/Apple-Inc
Team, T. I. (2022, February 16). How to read Apple’s balance sheet. Investopedia. Retrieved June 28, 2022, from https://www.investopedia.com/stock-analysis/021015/understanding-apples-balance-sheet-appl.aspx
Woodruff, J. (2019, March 6). Three primary methods used to make capital budgeting decisions. Small Business – Chron.com. Retrieved June 28, 2022, from https://smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting-decisions-11570.html
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