Answer 1. Capital Budgeting

Capital budgeting (or investment appraisal) is the process of determining the viability to long-term investments on purchase or replacement of property plant and equipment, new product line or other projects.

Capital budgeting consists of various techniques used by managers such as: 1. Payback Period 2. Discounted Payback Period 3. Net Present Value 4. Accounting Rate of Return 5. Internal Rate of Return 6. Profitability Index

Definition and Explanation of payback period:

The payback method is defined as the time, usually expressed in years, it takes for the cash income from a capital investment project to equal the initial cost of the investment. The choice between two or more projects is to accept the one with the shortest payback time. The determination of the payback period is a simple calculation of dividing the amount of the investment by the projected cash inflow per year. A shorter payback period equates to a higher return on the capital investment. Many companies have a maximum acceptable payback period and will only consider those projects whose payback period is less than the target number of years

Formula / Equation:

The formula or equation for the calculation of payback period is as follows:

Payback period = Investment required / Net annual cash inflow*

*If new equipment is replacing old equipment, this becomes incremental net annual cash inflow.

Advantages

The payback method is popular with business analysts for several reasons. The first is its simplicity. Most companies will use a team of employees with varied backgrounds to evaluate capital projects. Using the payback method and reducing the evaluation to a simple number of years is an easily understood concept. Identifying projects that provide the fastest return on investment is particularly important for companies with limited cash that need to recover their money as quickly as possible. Managers use the payback