Capital Budgeting: Selecting the Optimum Long‐term Investment

Capital budgeting is the selection of the optimum, alternative, long-term, investment opportunity. It tells where to invest corporate resources. Capital budgeting involves the calculation of the number of years taken to get money back, the return earned on a proposal, and the net present value of cash flows to be derived. The two broad categories of capital budgeting decisions are screening decisions and preference decisions. Screening decisions relate to whether a proposed project satisfies some current acceptance standard. Preference decisions apply to selecting from competing courses of action. This chapter discusses the various capital budgeting methods, including accounting rate of return, payback, discounted payback, net present value, profitability index, and internal rate of return. Contingent proposals, capital rationing, nondiscretionary projects, and the incorporation of risk into the analysis are also considered.