Capital Budgeting

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Definition: Capital Budgeting

Capital Budgeting is a process with which a business determines which project to undertake and which one to leave and not invest into. This is usually with respect to long term projects whose life is greater than 5 years or so.

Ideally, the business should invest in all those projects which enhance shareholder value but due to fund constraints, some projects are better than others. This is where capital budgeting process helps in taking a decision by evaluating the projects’ current and future (discounted) cash inflows and outflows and comparing them with the firm’s needs and requirements.

Some of the methods used for this process are

  1. Net present value Method which is most popular method.
  2. Internal Rate of Return
  3. Payback Period
  4. Black Scholes Model

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