Capital Budgeting

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What is Capital Budgeting?

Capital Budgeting (CB) is the internal process of identifying, evaluating, and implementing a firm's investment opportunities. In other words it is the process of preparing a plan for the raising of capital funds and for their deployment.

It can also be described as the process of determining which potential long-term projects are worth undertaking. Examples of typical CB projects are the purchase of new equipment or the introduction of a new product.

Goals of Capital Budgeting

CB aims at analyzing and agreeing on those investments that will enhance a firms competitive advantage and increase shareholder wealth.

Poor capital budgeting decisions will however decrease shareholder value and may ultimately result in a company's bankruptcy.

Multiple Investments and Inflows

The typical capital budgeting decision involves a large, initial and up-front investment, followed by several smaller additional investments and a series of smaller cash inflows (returns).

Capital Budgeting Sources

For an incorporated business, funds may be obtained from a wide variety of sources. The most important ones amongst these are:

• Issuing ordinary shares
• Issuing preference shares
• Issuing loans

Capital Budgeting Methods

To determine what are the right investments for an organization, several capital budgeting techniques are being used. The main ones are:

• Payback Period
• Net Present Value
• Internal Rate of Return

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