Capital Budgeting

For an organization, budgeting actually is an essential item that helps the organization to plan, enforce and control, because budgeting has a relation with future development. Therefore, capital budgeting practice is an important management tool which can help to lead the organization like what department need to improve more than last year, measure the organization’s performance and motivate their director, manager, and employees.

In long-term assets, capital budgeting might help to produce the advantages for the organization in the process of investment opportunities analysis for more than one year. For capital budgeting, there are some practices which are the method in avoiding the execution of compromising investments for reducing the future risks and errors. An organization need to make decision for an equity investment, they need to do the practices for investment analysis which include analysis and evaluation of different possibility which conform to the organization’s specifications. There are two groups of practices for investment analysis which are classification or cutting method for screening and robust method for selecting projects. The classification or cutting method is using the Accounting Rate of Return (ARR) and Payback Period (PP); however, robust method is using Modified Internal Rate of Return (MIRR), Net Present Value (NPV), Profitability Index (PI), and Internal Rate of Return (IRR), and to apply it to money’s time value.

In addition, there is also have practices for setting the discount rate which organization use the practices for calculate, discounting and constituting the percentage of the value of money in the cash flow as the time goes by. For calculating the discount rate, the organization uses the Debt Cost (DC), Weighted Average Cost of Capital (WACC), and Cost of Equity (CE). For doing an investment, the organization’s director must take some risks due to