Capital Budgeting

The decision on how to invest and further a firm’s value and investments is something that management has to deal with every day. Capital budgeting, according to Kidwell & Parrino (2009), “is the process of deciding which capital investment the firms should make” (pg. 313). A capital budget is integrated within every business plan. A business plan, which lays out a firm’s strategy for the next three to five years, has a capital budget that details all the resources a firm needs within that time period.

The purpose of this study is to analyze the techniques and methods used to make decisions about capital budgeting projects that firms embark on. A firm’s Chief Financial Officer’s staff and financial staff at the divisional and lower levels prepare the capital budget. The capital budget can consist of anything from office supplies to capital investments that can increase the value of the firm as well as the shareholders wealth (Kidwell & Parrino, 2009, pg. 314).

There are three types of potential investment projects for capital budgeting: independent, mutually exclusive, and contingent projects. Independent projects do not rely on cash flow. As long as a firm has enough money to cover the cost of all the projects it is considering, then approving or disapproving of a project has no effect on approving or disapproving the other projects (Kidwell & Parrino, 2009, pg.315).

Mutually exclusive projects are when only one project can be accepted among numerous projects. When a firm is considering multiply projects, when they decide to accept a project, then this disqualifies other projects from being considered (Kidwell & Parrino, 2009, pg. 315). For example, suppose the Chick-fil-a Corporation is looking at multiple sites to build a Chick-fil-a restaurant in the downtown Atlanta area. Once a site is chosen, then all other sites are no longer considered.

The last is contingent projects. This is when accepting one project depends on the acceptance of another...