What is capital budgeting?

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