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    Chapter 12

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    Mikasa Mikasa
    Capital budgeting is the process of evaluating potential long-term investments and major projects. It involves analyzing projects using techniques like net present value, internal rate of return, and payback period to determine if projects should be approved. Capital budgets summarize planned investments over multiple years to support strategic goals, while operating budgets cover shorter-term financial targets and expenses. Capital budgeting is used for replacement investments, expansion, safety projects, acquisitions, and other long-term capital expenditures.

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    Chapter 12

    Uploaded by

    Mikasa Mikasa
    128 views2 pages
    Capital budgeting is the process of evaluating potential long-term investments and major projects. It involves analyzing projects using techniques like net present value, internal rate of return, and payback period to determine if projects should be approved. Capital budgets summarize planned investments over multiple years to support strategic goals, while operating budgets cover shorter-term financial targets and expenses. Capital budgeting is used for replacement investments, expansion, safety projects, acquisitions, and other long-term capital expenditures.

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    Capital budgeting is the process of evaluating potential long-term investments and major projects. It involves analyzing projects using techniques like net present value, internal rate of return, and payback period to determine if projects should be approved. Capital budgets summarize planned investments over multiple years to support strategic goals, while operating budgets cover shorter-term financial targets and expenses. Capital budgeting is used for replacement investments, expansion, safety projects, acquisitions, and other long-term capital expenditures.

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    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    128 views2 pages

    Chapter 12

    Uploaded by

    Mikasa Mikasa
    Capital budgeting is the process of evaluating potential long-term investments and major projects. It involves analyzing projects using techniques like net present value, internal rate of return, and payback period to determine if projects should be approved. Capital budgets summarize planned investments over multiple years to support strategic goals, while operating budgets cover shorter-term financial targets and expenses. Capital budgeting is used for replacement investments, expansion, safety projects, acquisitions, and other long-term capital expenditures.

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    © All Rights Reserved
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    CHAPTER 12: BASICS OF CAPITAL BUDGETING

    Capital Budgeting

    - is the process a business undertakes to evaluate potential major projects or investments.


    - these are long-term decisions that are important to the company’s future
    - 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.
    Methodologies
    • Net Present Value (NPV)
    • Internal Rate of Return (IRR)
    • Modified Internal Rate of
    Return (MIRR)
    • Regular Payback
    • Discounted Payback
    • Qualitative Factors

    OPERATING BUDGET VS. CAPITAL BUDGET

    Operating Budget Capital Budget

     Summary of revenues, costs and expenses  Summary of planned investments in long-


    over a period of time that an entity uses to term assets to support the strategic
    plan its operation business plan
     Purpose is to set financial targets (revenues  Purpose is expansion and/or replacement
    & expenses)  Long-term. Usually covers 5 to 10 years,
     Short-term. Usually one year, reviewed reviewed periodically
    periodically

    WHEN IS CAPITAL BUDGET IS USED?

     Replacement: continuation of business /cost reduction


     Expansion of existing products & markets
     Expansion into new products & markets
     Safety and/or environmental projects
     Other projects (ie. office buildings, vehicles, etc)
     Mergers & acquisition

    STEPS IN CAPITAL BUDGETING

    1. Estimate cash flows (inflows and outflows)


    2. Assess riskiness of cash flows
    3. Determine the appropriate cost of capital (WACC) and compute for Net Present Value (NPV), Internal Rate of
    Return (IRR) and Payback
    4. Accept if NPV > 0 and/or IRR > WACC, and/or Payback is acceptable
    5. Monitor periodically

    TYPES OF CASHFLOWS
    Normal Cash Flow Normal Cash Flow Stream
    Stream
    • Cost (negative CF) followed by a series
    5
    of positive cash inflows. One change
    0
    -5 0 1 2 3 4 5 6 7 8 9 10 of signs.
    -10
    -15

    5 Non-normal Cash Flow Non-normal Cash Flow Stream

    0 Stream • Two or more changes of signs. Most common:


    0 1 2 3 4 5 6 7 8 9 10 Cost (negative CF), then string of positive CFs,
    -5 then cost to close project.
    • Examples include nuclear power plant, strip
    -10 mine, etc.
    -15

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