The following document serves as a synopsis of the general capital budgeting process and how it is implemented within organizations is conveyed and defined. The key terms that coincide with the capital budgeting process are also defined. Risk analysis based on NPV (Net Present Value) is performed on the salvage values before and after sales tax values along with the various ranges in sales.
Every organization requires some foundation of funds to maintain its operation and acquire competitive advantages. Whether it’s a manufacturing or servicing firm, it requires financing. Sources of financing can be acquired through debt, equity, bank loans, bond issuance, and issuance of preferred and/or common stock. The amount of debt and equity builds the firm's capital structure. The firm's corporate or business strategy is the proportion of capital structure it needs to finance its operation. The combination of debt and equity totals the cost of capital for the firm. The cost of capital is the weighted average of each capital source fund. The cost of capital is known as the WACC (Weighted Average Cost of Capital). This calculation entails numerous factors such as profitability, credit worthiness, debt history, and other finance factors. WACC gives a firm a benchmark to where it should receive any gain. Since firms are continuously trying to improve its infrastructure, business processes, or competitive priorities, WACC is heavily utilized in capital budgeting.
As previously mentioned, a firm or business has to make rational decisions about which project to pursue in order to have a beneficial Return of Investment (ROI). Whether that is determining projects such as breaking foundation for a new plant or perhaps investing in long-term ventures are questions worth pursuing for a business. The firm's main objective is to increase stakeholder’s wealth. Capital budgeting is the process of analyzing cash inflows and outflows of any project in order to determine if its returns will be feasible to the firm's lucrative goals and stakeholders' Internal Rate of Return (IRR). The cash inflows are estimated returns of investment evaluated at a particular market value rate. The initial cash outflow is a disbursement fund to allocate resources to implement the project. Capital budgeting also consists of weighing the Payback Period (PBP) with respect to cash inflows. The PBP assesses when the firm breaks-even becomes profitable. Capital budgeting is also known as an investment appraisal. Overall, the capital budgeting process is a key resource that businesses utilize to make rational and qualified financial decisions for long-term projects.
Glossary of Concepts and Terms:
Cash flow analysis (time zero initial investment cash flows, operating life cash flows, terminal period end of project cash flows)
Cash flow timeline, cash inflows and outflows directly related to the production and sale of a firm’s products or services. The cash flow timeline can be calculated as the net income plus depreciation and other noncash charges. Used by financial professionals to focus attention on current and prospective inflows and outflows of cash.
Conventional cash flow stream
Cost of capital concept (and implications to valuation)
Discount rate is the interest rate charged to commercial banks and other depository institutions for
