Capital budgeting can be explained to be a firm’s decision to invest its current funds most effectively in long term activities in anticipation of an expected flow of future benefits over a series of years.
The investment decisions could be in the form of additions, dispositions, replacements and modifications of activities or asset base that would ensure good returns on the utilization of the firm’s assets. Therefore, the manager has to give consideration to the following factors when capital budgeting decisions are involved viz.
(a) The existence of huge expenditures or large cash exposure.
(b) The involvement of long gestation period between initial expenditures and returns and
(c) The expectation of higher returns because of factors (a) and (b) above.
Going by the factors above, the manager must not fail to make appropriate investment or selection of good projects because, the volume of fixed assets far exceed current assets and the owners of the company (shareholders) are long term investors, whose high expected returns can only be met with the higher returns from long term assets.
These assertions, call for the need to examine the different methods of selecting investments in long term assets. Following are the main tools used to evaluate the project:
1. Non Discounted Cash flow Techniques :
a. Payback period (PBP):
b. Accounting Rate of Return (ARR)
c. Net Present Value (NPV):
d. Internal Rate of Return (IRR)
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