What Is Capital Budgeting?

WHAT IS CAPITAL BUDGETING?

Capital budgeting also known as investment appraisal is the planning process by which a company decides which long-term investments (capital investments) to make. The investment portfolio could include and/ or range from new production machinery to real estates and acquisitions. It is simply put, a budget for major capital, or investment, expenditures expected to generate cash flows over several years. Making this investment decision requires estimating the value of each opportunity or project, which is a function of the size, timing and predictability of future cash flows. Capital budgeting usually involves the estimation of cash flows; assessing risk of cash flows as well as the overall evaluation of these cash flows.

Capital budgeting involves techniques and methods which make use of the incremental cash flows from each potential investment such as; the accounting rate of return, net present value, profitability index, internal rate of return, equivalent annuity as well as hybrid methods like payback period and discounted payback period.

Outsourcing is the practice of turning over responsibility of some to all of an organization's information systems applications and operations to an outside firm. This practice is widely believed (sometimes erroneously) to lead to cost savings and/or to free company resources for other activities.

Take for example, I am the manager in charge of capital budgeting in an IT firm, my decision will depend on my institutions struggle with funding IT infrastructure, services, and strategic projects. I can therefore, using my knowledge of capital budgeting and the real options which exist for my company, by going through the aforementioned methods to determine whether to outsource such projects.