Capital budgeting is the process a business undertakes to evaluate potential major projects or investments. Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected.
Some Times Capital budgeting Is use to determine which projects to pursue include throughput analysis, net present value (NPV), internal rate of return, discounted cash flow, and payback period.
Net Present Value (NPV)
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project.
where:Rt =Net cash inflow-outflows during a single period ti =Discount rate or return that could be earned in alternative investmentst =Number of timer periods
NVP can also determine as
where:TVECF=Today’s value of the expected cash flowsTVIC=Today’s value of invested cash
Types of Capital Budgeting
Throughput Analysis Discounted cash flow (DCF) analysis