Definition of Capital Budgeting
Capital budgeting is a process used by companies for evaluating and ranking potential capital expenditures or investments that are significant in amount. A few examples of capital expenditures include:
- Purchase of new equipment
- Rebuilding existing equipment
- Purchasing delivery vehicles
- Constructing additions to buildings
Examples of Capital Budgeting Calculations
Capital budgeting usually involves the following calculations for each project:
- Future accounting profit by period
- Future cash flows by period
- Present value of the cash flows by discounting them with an appropriate interest rate
- The number of years it takes for a project’s cash flow to pay back the initial cash investment
- An assessment of risk along with the urgency of the project
