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Home » Finance Homework Help » Capital Budgeting
Capital Budgeting
Capital budgeting or investment decisions are of considerably importance to the firm since they tend to determine its value by influencing its growth, profitability and risk. An efficient allocation of capital is the most important finance function in the modern times. It involves decisions to commit the firm’s funds to the long term assets.

A capital budgeting decision may be defined as the firm’s decision to invest its current funds most efficiently in the long-term assets in anticipation of an expected flow of benefits over a series of years. The long-term assets are those that affect the firm’s operation beyond the one-year period. The firm’s investment decisions would generally include expansion; acquisition decisions would generally include expansion, acquisition, modernization and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision. Decisions like the change in the methods of sales distribution, or an advertisement campaign or a research and capital. In this chapter, we assume that the investment project’s opportunity cost of capital is known. We also assume that the expenditure and benefits of the investment are known with certainty.

It explains the nature of investment decisions, its types and also investment evaluation criteria. Calculations of NPV and IRR are its main contributions. Risk analyzing in capital budgeting includes nature of risk, statistical and conventional techniques of risk analysis sensitivity analysis, scenario analysis simulation analysis etc. it also describes the cost of capital with its significance and concepts. It determines component costs of capital, cost of debt, cost of preference capital, cost of equity and capital asset pricing etc.

Some of its important topics are:

1. Importance, nature and types of investment decisions
2. Capital budgeting
3.
Investment evaluation criteria
4.
Nature of risk
5. Net present value method
6.
Preference and equity capital
7. Profitability index and internal rate of return
8. Sensitivity and simulation analysis
9. Significance of capital and debt

 

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