You have learned five capital budgeting techniques in this course. Describe the details and analyze the limitations of each of these capital budgeting techniques. Also, other than the capital budgeting technique itself, please provide your own views regarding what other factors which potentially may cause the inaccuracy of capital budgeting results in reality. You need to provide real life examples to illustrate your arguments. (not more than 700 words in total)

Techniques of capital budgeting with limitations :

1. Payback period : Under this method company calculate the time period which is required to recover the initial cost of investments. Generally, project with lesser payback period is accepted as compare to other project.

Limitation : A. It doesn't consider time value of money.

B. It ignores the profits generated after payback period.

3. It ignores the Profitability of the project.

4. It is very simple technique and doesn't follow any scientific method of calculations.

2. Net present value technique : NPV is the most popular method used in capital budgeting decisions. Under this method, present value of future cash flows is ascertained. NOV = PV of cash inflow- initial investment. Project with high NPV is acceptable.

Limitations : A. It ignores Profitability of the project.

B. It is not useful when projects require different amount of investments and with different economic life.

C. It is very difficult to determine the appropriate discount rate at which cash flows will be discounted.

D. It doesn't consider the time period to recover the initial investment.

3. Internal rate of return : The main objective of this technique is to calculate the investment's rate of return. It focuses on the Profitability of the project which is ignored by the above two techniques. It is that rate where PV of cash inflows is equal ro PV of cash outflows or we can say at this rate, NPV is equals to zero. The project with high IRR must be selected.

Limitations : A. It involves lots of calculations. Many a times hit and trial method need to be used.

B. It always assumes that earnings are reinvested at IRR. But it is not always true.

C. Like NPV it also doesn't consider the time period to recover the initial investment.

D. As its name indicates it consider only internal factors, external factors like risk free rate, inflation, cost of capital are ignored.

4. Profitability Index : The profitability index (PI) is a measure of a project's attractiveness. This is calculated by dividing the PV of cash flows by the initial investment. If PI greater than 1.0 then it is deemed as a good investment or vice versa.

Limitations : A. It ignores sunk cost e.f. R&D expenditure before starting the project.

B. Like NPV, it is very difficult to determine appropriate discount rate for discounting the future cash flows.

C. It is not suitable where life of the projects are different.

5. Accounting rate of return : Under this technique, total net income of the project is divided by initial investment for the ascertainment of profits. Project with high accounting rate of return must be accepted.  

Limitations : A. It doesn't take into account time value of money.

B. It doesn't remain constant over useful life of the project.

C. Like IRR, this method also doesn't consider external factors like risk free rate, inflation, cost of capital etc.

D. It focuses on percentage not on number of years to complete the project.

Factors which potentially may cause the inaccuracy of capital budgeting results in reality :

There are many risks which affect the capital budgeting decisions. These are as follows :

1. Project risk : In capital budgeting, many a times project has certain risk. We always take in consideration expected cash flows. Initial investment is fixed which we have to spend. But future cash flows are uncertain. We can only expect them while applying the techniques. There is a impact of boom and depression period, inflation or deflation which is not considered at all. That's why capital budgeting fails to provide sound decisions.

2. Market risk : change in interest rates, poor condition of the economy leads to decrease in demand e.g. in covid-19 pandemic , people don't have enough money for buying the goods and this leads to adverse fluctuations in cash inflows.

3. National and international risks: Change in tax rates, tariffs and quotas, change in foreign exchange risks, unstable political structures also effect the decision of capital budgeting. There is a possibility that selected project may become worst due to these changes or risks.

So above are the factors which adversely affect the decision of capital budgeting