Strategic Financial Management: Capital Budgeting, Risk Analysis, and Profitable Investments

Purpose of the Standard Operating Procedure Publication

This publication is aimed at stipulating the intended procedural action in the finance department projects. The finance department is an important docket in a firm that deals with procedures involving the receipt and payment of past and future obligations in the docket. The firm is on the verge of replacing heavy capital equipment that has been rendered obsolete due to the changes in technology. The new machine will help in the production process and will reduce the number of employees from the technical team by 30% hence saving on labor costs.

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The Capital Budgeting Process

The process entails the identification of an opportunity in the firm that may help increase the profits like that of buying the heavy machinery while replacing the old one. The estimated cash flows of the project are then assessed, as well as the risk involved in the project implementation and the methods of financing of the project which may include debt finance, equity financing, or full payment of the machinery using retained earnings. Determine the full cost of the project and its profitability, implementation of the project, and finally the review of the project after a later date. The department intends to use debt financing for the purchase of the machinery. This is because the machinery is quite expensive and may cost the firm a large sum of money that it may not be able to fully recover.

Project Analysis

The project has some criteria to meet including that of having a reduced level of risk to the business so that it may be implemented (Herdjiono & Damanik, 2016). It should have a high profitability margin with a short payback period. It should be able to help the organization meet its long-term and short-term organizational goals.

Expected Rates

The Internal Rate of Return is expected to be at 14 % on return to investments. The expected payback period should be short like 3 years. This will help the firm make long-term profits using the asset it purchased while also obeying the loan liability terms of the debt finance used to purchase the asset. The Net Book Value of the asset in question should be high projecting a low rate of the annual depreciation rate of the machinery. The depreciation rate of the machine is expected at 10% with a useful life of 8 years.

Project Documentation

The project is expected to be financed using debt equity and this will entail the use of collateral. The collateral on the loan will be the land of the firm hence documents like the title deed will be required, the financial statements of the company like the balance sheet and the income statement will also be required as well as the statement of cash flow and that of changes in equity before the financing of a loan by a the bank. The portfolio analysis of the project attains to the profit-making of the project and the meeting of financial goals without necessarily putting the business at risk.

Risk Analysis

The project may be involved with some risk including that of the machine being faulty and this can be reduced through buying a machine with a warranty. The training of the employees on how to use the machine should also be done. The use of insurance to cover various unanticipated risks should also be done.

The Retained Profit Concern of the Project

The project will ensure that a 4% rollover of the profits (retained earnings) will be used in the implementation of other projects of the firm. This will help maintain a good profitability index and higher working capital for the firm.

Conclusion

The continued increase in the level of profits of the firm is to be credited to the good financial management of the firm by the finance department. The use of debt financing in financing the project is necessary so as not to interfere with the liquidity ratio of the firm. It is the role of the finance department to organize the budget and present it to the finance committee of the firm so that it can be approved.

Reference

Herdjiono, I., & Damanik, L. A. (2016). Pengaruh financial attitude, financial knowledge, parental income terhadap financial management behavior. Jurnal Manajemen Teori dan Terapan| Journal of Theory and Applied Management, 9(3). http://e-journal.unair.ac.id/index.php/JMTT/article/view/3077