Explain what is capital budgeting 300 words

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Expert Solution

Capital budgeting is a method of analyzing and comparing substantial future investments and expenditures to determine which ones are most worthwhile. Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected.

An organization is often faced with the challenges of selecting between two projects/investments or the buy vs replace decision. Ideally, an organization would like to invest in all profitable projects but due to the limitation on the availability of capital an organization has to choose between different projects/investments.

Objectives of capital budgeting -

1) Selecting profitable projects.

2) Capital expenditure control

3) Finding right source for funds

Capital budgeting process (Steps) -

1) Finding investment opportunities

2) Evaluations of all investment proposals

3) Choosing the most profitable investment

4) Capital budgeting and apportionment

5) Performance review

Capital budgeting techniques -

1) Payback period method

2) Net Present value

3) Accounting Rate of Return

4) Internal Rate of Return (IRR)

5) Profitability Index

Conclusion - Capital budgeting is a predominant function of management. Right decisions taken can lead the business to great heights. However, a single wrong decision can inch the business closer to shut down due to the number of funds involved and the tenure of these projects.

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