Capital budgeting

Welcome to our session on capital budgeting. Capital budgeting is the process by which organizations decide which investments or long term projects to pursue, such as building a facility, launching a product, or investing in new technology. In the USA and UK, terms like investment appraisal or project selection are also used. This critical area of corporate finance determines which projects could generate value for shareholders and ensures resources are allocated to support a company's long term strategy and growth. The capital budgeting process involves key steps, generating ideas, evaluating projects, estimating future cash flows, selecting a discount rate that reflects risk, often the company's weighted average cost of capital or WACC and selecting projects based on quantitative methods. Common appraisal techniques include net present value, which calculates the present value of expected cash flows, internal rate of return, estimating project return, and payback period, which shows how long it takes to recover the initial investment. Not all projects carry the same level of risk, so it's important to reflect this in our analysis. The discount rate used to value future cash flows serves as a measure of both the firm's inherent risk and the specific risk of the project. Less established firms or high risk endeavors should typically be assessed with higher discount rates, while safer, more predictable projects may justify a lower rate. Sometimes it is appropriate to adjust