Capital Budgeting

Good Essays
There are a number of techniques of capital budgeting. Some of the methods are based on the concept of incremental cash flows from the projects or potential investments. There are some other techniques of capital budgeting that are based on the accounting rules and accounting earnings.
However, the techniques based on the accounting rules are considered to be improper by the economists. The hybrid and simplified techniques of capital budgeting are also used in practice. Capital budgeting is the process of managing the long-term capital of a firm in the most profitable way.

The prime task of the capital budgeting is to estimate the requirements of capital investment of a business. The capital allocation to various projects depending on their needs and selection of proper project for the business also fall under the canopy of capital budgeting concept.

Some of the major techniques of capital budgeting are: * Profitability index * Net present value * Modified Internal Rate of Return * Equivalent annuity * Internal rate of return

Profitability Index
The profitability index is a technique of capital budgeting. This holds the relationship between the investment and a proposed project's payoff. Mathematically the profitability index is given by the following formula:
Profitability Index = (Present Value of future cash flows) / (Present Value of Initial investment

The profitability index is also sometimes called as value investment ratio or profit investment ratio. Profitability index is used to rank various projects.

Net Present value
Net present value (NPV) is a widely used tool for capital budgeting. NPV mainly calculates whether the cash flow is in excess or deficit and also gives the amount of excess or shortfall in terms of the present value. The NPV can also be defined as the present value of the net cash flow.

Mathematically,

NPV = ?(Ct / (1+r)t) - C0 , where the summation takes the value of t ranging from 1 to n

You May Also Find These Documents Helpful

  • Better Essays

    Capital Budgeting

    • 2621 Words
    • 11 Pages

    Capital Budgeting Introduction Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the firm's goal of maximizing owner wealth. A firm using capital budgeting, their goal is to see if there fixed income will cover itself for profit. Fixed incomes are things such as land, plant and equipment. When a firm using a machine to produce its good or service. They most of the time what the machine to produce the amount that they paid for the machine…

    • 2621 Words
    • 11 Pages
    Better Essays
  • Powerful Essays

    Capital Budgeting

    • 5574 Words
    • 23 Pages

    Capital budgeting Making decisions having significant future benefits or costs for various entities and their stakeholders. Capital budgeting is the backbone of financial economics. Related topics in financial economics include: the time value of money, the meaning of net-present value, accounting concepts consistent with present-value calculations, discount rates, and option valuation techniques. In the public sector, the term is often exclusively associated with infrastructure investments…

    • 5574 Words
    • 23 Pages
    Powerful Essays
  • Better Essays

    Capital Budgeting

    • 1425 Words
    • 6 Pages

    Week 4 Discussion Question 1b Introduction Capital budgeting is one of the most crucial decisions the financial manager of any firm is faced with...Over the years the need for relevant information has inspired several studies that can assist firms to make better decisions. These models are assigned so that they make the best allocation of resources. Early research shows that methods such as payback model was more widely used which is basically just determining the length of time required for the…

    • 1425 Words
    • 6 Pages
    Better Essays
  • Satisfactory Essays

    Capital Budgeting

    • 267 Words
    • 2 Pages

    Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell. An objective for these decisions is to earn a satisfactory return on investment. The process of evaluating and prioritizing capital investment opportunities is called capital budgeting. Capital budgeting relies heavily on estimates of future operation results. These estimates often involve a considerable degree of uncertainty and should be evaluated accordingly. In addition…

    • 267 Words
    • 2 Pages
    Satisfactory Essays
  • Powerful Essays

    Capital Budgeting

    • 2504 Words
    • 11 Pages

    LIST OF CONTENTS DECLARATION 2 ACKNOWLEDGEMENT 3 LIST OF CONTENTS 4 INTRODUCTION TO CAPITAL BUDGETING 5 CAPITAL BUDGETING PROCESS 7 ORGANIZING CAPITAL BUDGETING PROCESS IN LARGE FIRMS 8 CAPITAL BUDGETING DECISION RULES 9 CAPITAL BUDGETING: EMERGING ISSUES AND TRENDS 12 CRITIQUE 13 CONCLUSION 15 BIBLIOGRAPHY 16 Introduction to Capital Budgeting Indian economy as a whole has largely been insulated against the global economic slowdown, the Indian real estate sector though has been seriously…

    • 2504 Words
    • 11 Pages
    Powerful Essays
  • Good Essays

    Capital Budgeting

    • 804 Words
    • 4 Pages

    CAPITAL BUDGETING The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark. Also known as "investment appraisal." Generating investment project proposals consistent with the firm’s strategic objectives; Estimating after-tax incremental…

    • 804 Words
    • 4 Pages
    Good Essays
  • Powerful Essays

    Capital Budgeting

    • 1999 Words
    • 8 Pages

    Corporate Finance Capital Budgeting Course Outline CAPITAL BUDGETING Course outline Key Principles in Capital Budgeting: Criteria for Investment Projects Net Pesent Value Internal Rate of Return Payback Profitability Index Finding Cash Flows Maria Ruiz 1 Financial Management Financial management is largely concerned with financing, dividend and investment decisions of the firm with some overall goal in mind. Corporate finance theory has developed around the goal of shareholder…

    • 1999 Words
    • 8 Pages
    Powerful Essays
  • Powerful Essays

    Capital Budgeting

    • 3650 Words
    • 15 Pages

    Report on Capital Budgeting Abstract This report deals with • The nature of capital investment appraisal • The techniques available for evaluating capital investments • The limitations of these techniques • The capital budgeting practices in select countries Introduction: Some of the major responsibilities of top management are in the area of long range planning. Allocating resources to competing uses is one of the most important decisions a manager has to make. Executives are constantly…

    • 3650 Words
    • 15 Pages
    Powerful Essays
  • Good Essays

    Capital Budgeting

    • 788 Words
    • 4 Pages

    WHAT IS CAPITAL BUDGETING? 1. 2. Decision making process of selecting and evaluating longterm investments. Examples include the decision to replace equipment, to develop new product, or to build new shop at a new branch of operations. It is very crucial for companies to make the right decisions because these projects require a huge amount of cash outflow committed for many years. A right decision will increase the firm’s value as well as the shareholders’ wealth. A wrong decision will…

    • 788 Words
    • 4 Pages
    Good Essays
  • Powerful Essays

    capital budgeting

    • 9954 Words
    • 55 Pages

    3 : Literature Review in Capital Budgeting Studies 3.1 Introduction 3.2 Literature Review : Foreign Studies 3.3 Literature Review : Indian Studies 3.4 Conclusion 92 Chapter 3 : Literature Review in Capital Budgeting Studies 3.1 Introduction: A number of researchers in finance and accounting have examined corporate capital budgeting practices. Many of these articles survey corporate managers and report the frequency with which various evaluation methods, such…

    • 9954 Words
    • 55 Pages
    Powerful Essays