Capital Budgeting

Capital budgeting is the process that businesses use to evaluate and select long-term investments and projects that will generate value over time. These investments often involve large sums of money, such as purchasing equipment, expanding facilities, or launching new products. Capital budgeting decisions are typically made by analyzing the projected cash flows, costs, and potential returns of each project using techniques like Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period.

Example

A manufacturing company might use capital budgeting to decide whether to invest in new machinery. By calculating the NPV and IRR of the project, the company can determine if the investment will generate a positive return over time.

Key points

• Capital budgeting involves evaluating long-term investments and projects.

• Techniques include NPV, IRR, and Payback Period to assess the value of projects.

• Helps companies allocate resources efficiently and maximize long-term profitability.

Quick Answers to Curious Questions

What is the purpose of capital budgeting?

The purpose is to evaluate and select long-term investments that will create value for the company, helping to maximize profitability and ensure efficient resource allocation.

What are common capital budgeting techniques?

Common techniques include Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period, each helping to assess the financial viability of a project.