The Basics of Capital Budgeting

Running head : The Basics of Capital Budgeting

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Capital budgeting or investment appraisal is a planning process used by management in a firm to determine whether it 's planned long term investment in new machinery , new plants , new products , and research and development projects are worth investing in them in terms of future returns . Businesses everywhere are always seeking for ways to grow with an aim of increasing the shareholders value . This can only be done through deciding on , and choosing the best investment

from a basket of competing alternatives after factoring in the firm 's resources its readiness to commit , risks associated with the proposals and whether the proposed project coincides with the firm 's long term plan (Dayananda Don , 2002

Money changes value over time . The value of a dollar today will not be the same tomorrow . An investment appraisal on any investment decision follows this idea of time value of money . This concept of time value of money is closely related to interest rate which leads to discount factor . In capital budgeting , investors try to find the current value of capital good e .g . new machinery , against its value in future . Time value of money lays out the different factors that are important in investing , and is part of the opportunity cost that will guide the decision maker on whether to invest on a capital good or not . Techniques used in capital budgeting include : accounting rate of return , net present value , profitability index...