How to Determine the Desirability of Investing in a Project?

Posted by FionaDeLuna on February 1st, 2017

Before a company takes the decision to accept a project, it needs to find out whether it will bring money and opportunities or not, and therefore, whether it is reasonable or not to pursue it. This is done through what is known as capital budgeting. If you have ever worked out a budget for your household, then understanding capital budgeting will be of no difficulty to you.

To understand whether or not a project is desirable, management of a company typically has to find the answers to at least three questions.

1. How much will it cost?

To begin with, the business needs to find out the actual price of the assets. It’s also crucial to know any future investment costs.

2. How soon will it be possible to return the money?

At this step, management has to forecast how much money the project will possibly bring. Although there is no way to make an absolutely correct prediction, it is still necessary to make as accurate a forecast as possible.

Even if a project is affordable for a company, but doesn’t provide a chance for returning the initial investment, it shouldn’t be pursued unless there is a strategic perspective.

3. What effect will it have on other projects?

Some projects are independent, which means that they do not affect other projects of the company. However, in most cases the situation is different, and acceptance of a project in one way or another influences other projects. Such projects are called mutually exclusive.

We should also point out that capital budgeting always includes decisions of two types, investment and financial ones. A project may seem not desirable from a financial point of view (for instance, if it won’t allow to return money in a reasonable period of time), yet be desirable from an investment point of view. These decisions depend on the unique features of a business, as well as the situation at the market.