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7 Examples of Capital Budgeting

 , updated on October 20, 2017
Capital budgeting is the process of planning investments in a business. It is an element of strategic planning that produces a capital budget. In many cases, a firm has a long list of capital projects under consideration that far exceed the firm's resources. Capital budgeting is a process of comparing investments to plan capital spending. The following are common considerations.

Strategy

A firm's plan to achieve its objectives and goals. For example, if a firm plans to reduce its environmental impact capital investments in things such as energy infrastructure may be required.

Return

The present value of future cash flows that the investment will generate. Modeled with techniques such as return on investment and payback period.

Cost of Capital

An investment that doesn't return more than your cost of capital has a negative real return. For example, a firm with a cost of capital of 11% may require return on investment of at least 20%. As such, this firm will find fewer worthy investments as compared to a firm with a 4% cost of capital.

Liquidity

The cash position and cycles of an organization. It is critical that an organization never run out of cash. As such, a firm that is low on cash may have to forgo investments even if they are critical to strategy or have a high payback.

Risk

A low risk investment with return of 10% may be far more attractive than a high risk investment with a return of 15%. Modeling risk exposure for significant capital expenditures is basic due diligence.

Competition

In some cases, an investment is required to stay competitive. As such, return can be modeled by how much the firm will lose if the investment isn't made.

Compliance

Investments that are required by rules and regulations such as replacing equipment that is polluting the environment or dangerous to workers.
Overview: Capital Budgeting
Type
Definition
The process of planning investments in a business.
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