Capital Budgeting, Explained.

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Capital investment decisions are those decisions that involve current outlays in return for a stream of benefits in future years. It is true to say that all the firm's expenditures are made in expectation of realizing future benefits. Investment decisions are extremely important because they have a major long term effect on a firm's operations. For example, when BMW decided to build some of its cars in Greece, South Carolina, it made an investment in additional productive capacity that will affect its labor and transportation costs for many years to come.

Labor to build the cars is supplied by American rather than German workers and as such labor costs are largely determined by business conditions in the United States rather than in Germany. Transportation costs are greatly reduced for cars sold in the United States because cars can be shipped from South Carolina rather than Continental Europe. Investment decisions involving the acquisition of long lived assets are often referred to as capital expenditure decisions because they require that capital (company funds) be expanded to acquire additional resources. Investment decisions are also called as capital budgeting decisions. Most firms carefully analyze the potential projects in which they may invest. The process of evaluating the investment opportunities is referred to as capital budgeting and the final list of approved projects is referred to as the capital budget.

There are many definitions as pronounced by various financial analysts as far as capital budgeting is concerned: According to Western and Brigham: "Capital budgeting involves the entire process of planning expenditures whose returns are expected to extend beyond one year. The choice of one year is arbitrary, of course, but is a convenient cut-off point for distinguishing among the various kinds of expenditure".

According to John Hampton, "Capital budgeting describes the firms formal planning process for the acquisition and investment of...
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