capital budgeting

Examples of capital budgeting in the following topics:

• The Goals of Capital Budgeting

  • Capital Budgeting, as a part of budgeting, more specifically focuses on long-term investment, major capital and capital expenditures.
  • The main goals of capital budgeting involve:
  • The real value of capital budgeting is to rank projects.
  • The highest ranking projects should be implemented until the budgeted capital has been expended.
  • When a corporation determines its capital budget, it must acquire funds.

• Risks Involved in Capital Budgeting

  • The process of capital budgeting must take into account the different risks faced by corporations and their managers.
  • Capital budgeting (or investment appraisal) is the planning process used to determine whether an organization's long term investments, such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing.
  • There are numerous kinds of risks to be taken into account when considering capital budgeting including:
  • Identify the different risks that must be accounted for in the capital budgeting process

• Defining Capital Budgeting

  • Capital budgeting is the planning process used to determine which of an organization's long term investments are worth pursuing.
  • Capital budgeting, which is also called "investment appraisal," is the planning process used to determine which of an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing.
  • It is to budget for major capital investments or expenditures.
  • Many formal methods are used in capital budgeting, including the techniques as followed:
  • Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment.

• Defining the IRR

  • IRR is a rate of return used in capital budgeting to measure and compare the profitability of investments; the higher IRR, the more desirable the project.
  • The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments.
  • A firm (or individual) should, in theory, undertake all projects or investments available with IRRs that exceed the cost of capital.
  • Explain how Internal Rate of Return is used in capital budgeting

• Other Considerations in Capital Budgeting

  • Traditional capital budgeting theory holds that investments should be made when the simple net present value (NPV) of an investment opportunity equals or exceeds zero.

• The Marginal Cost of Capital

  • The marginal cost of capital is the cost needed to raise the last dollar of capital, and usually this amount increases with total capital.
  • The marginal cost of capital is calculated as being the cost of the last dollar of capital raised.
  • Generally we see that as more capital is raised, the marginal cost of capital rises .
  • The Marginal Cost of Capital is the cost of the last dollar of capital raised.
  • Describe how the cost of capital influences a company's capital budget

• Dividend Irrelevance Theory

  • Under perfect market conditions, stockholders would ultimately be indifferent between returns from dividends or returns from capital gains.
  • Dividend irrelevance follows from this capital structure irrelevance.
  • Under these frictionless perfect capital market assumptions, dividend irrelevance follows from the Modigliani-Miller theorem.
  • However, the total return from both dividends and capital gains to stockholders should be the same.
  • Merton Miller, one of the co-authors of the capital irrelevance theory which implied dividend irrelevance.

• The Forecast Budget

  • A cash budget is all about liquidity, and therefore forecasting what available liquidity will be required over a given period is the primary input for forecasting budgets.
  • For example, accounts receivable, short-term financing options, and various other sources of income may directly convert into usable capital.
  • However, budgeting should either build these into the current budget forecast or utilize them during the next calculation of budgetary requirements.
  • A third option for projecting cash budgets is accrual reversal.
  • Budgeting is an estimation, often adjustments over time.

• Introducing the Budget Constraint

  • Budget constraints represent the plausible combinations of products and services a buyer can purchase with the available capital on hand.
  • The concept of budget constraints in the field of economics revolves around the idea that a given consumer is limited in consumption relative to the amount of capital they possess.
  • This is achieved through using budget constraints, which represent the plausible combinations of products and/or services a buyer is capable of purchasing with their capital on hand.
  • The way economists demonstrate this arithmetically and visually is through generating budget curves and indifference curves.
  • Discuss the role of the budget set and indifference curve in determining the choice that gives a consumer maximum satisfaction

• Budget Resolutions

  • Congress must create an annual budget resolution in response to the President's budget request according to the Congressional Budget and Impoundment Control Act of 1974 (also known as the Congressional Budget Act) .
  • The budget resolution establishes budget totals, allocations, entitlements, and sometimes includes reconciliation instructions to certain House or Senate committees.
  • April 15th is the target date for congressional adoption of the budget resolution set by the Congressional Budget Act.
  • In some instances, Congress has not adopted a budget resolution.
  • The Congressional Budget and Impoundment Control Act of 1974 (Congressional Budget Act), created during the Nixon administration, established the current budget resolution process.