Capital Budget
Capital Budgeting
Capital Budgeting is an important area in business finance management as well as everyday life. Individuals and businesses have goals to achieve but to accomplish goals these individuals must make choices whether it involves investment for the business or even starting a business. Through the process of analysis and evaluation capital budgeting helps individuals make the right choice for his or her business. The purpose of this paper is to define capital budgeting, explain the process as well as the important administrative considerations. Also the paper lists and explains types of allowable depreciation and what is normally used as the discount rate in the net present value method.
Capital budgeting is a decision-making process involving business evaluation of long-term investment as well as the planning and management of those investments. Companies’ uses this method to determine whether or not pushing a project forward or investment on fixed assets are worth it. Fixed asset are material goods that a firm does not plan to sell within one year, such as land, building, equipments, machinery, vehicles, etc. (Keown, Martin, Petty & Scott, 2005).
Disney is a good example of a company that uses capital budgeting when deciding if to invest in certain projects. In 1955 this company decides to invest $17.5 million to build a new park so the management team decides to use capital budgeting as a tool for decision-making of this project. Building a new park was a success and Disney’s parks and resorts make up 30% of the company’s revenue. Disney learns three lessons from this investment concerning capital budgeting. According to Keown, Martin, Petty, and Scott (2005), “Lesson #1: Capital-budgeting decisions are critical in defining a company’s business. Lesson #2: Very large investments are frequently the result of many smaller investment decisions that define a business strategy. Lesson #3: Successful investment choices lead to the development of managerial expertise and capabilities that influence the firm’s choice of future investments” (P. 334).
Considerations of Capital Budgeting
Finding the right project to invest is a difficult task; therefore, firms need to analyze important administrative considerations in the capital budgeting process. Fist managers need to search and distinguish investment opportunities and examine the cash flow for the project. Second it is important to consider time value of money by data collection and using money tools, such as a timeline and Net Present Value. Timeline includes information on timing of cash flows, and interest rate earned for a period. The figure below is an example of a timeline for a company that has annual inflows and outflows for a period of four years (Keown, Martin, Petty & Scott, 2005, P. 128).
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