Capital Budgeting

Capital Budgeting

FINC620 / Financial Management

01 April 2013

Abstract

Capital is the use of long-term assets in the manufacturing of a given company’s products and services. Budgeting is the planning that outlines the projected expenses necessary to finance a project. Therefore, a capital budget (and other financing tools) is used to plan the investment of a firm’s long-term assets in order to determine what projects are good investments for the company that will add value to the firm just as it is used to determine what projects are not good and therefore would need to be rejected (Brigham & Ehrhardt, 2011).

Capital Budgeting is critically important to an organization and probably involves the most important decisions any manager of an organization must make because projects should only be accepted in correlation to their primary operating goal which is to maximize the firm’s intrinsic value which, in turn maximizes the stock price per share over the long-run and thus maximizes shareholder wealth (Brigham & Ehrhardt, 2011)..

There are six techniques described in the text and used in capital budgeting analysis in determining what projects a company should accept or reject; Net Present Value (NPV), Internal Rate of Return (IRR), Modified Internal Rate of Return (MIRR), Profitability Index (PI), Regular Payback & last Discounted Payback (Brigham & Ehrhardt, 2011).

Capital Budgeting: Background

Capital Budgeting is a planning process that is used to help determine which projects should be approved by the company that will add value to that organization. It is a step-by-step process that also helps to determine the merit of each individual investment project. The decision of whether or not to accept or reject a particular project involves determining the rate of return on investment of that project. Capital budgeting provides that information and also creates accountability as well as measurability. Any company that invests its...