Week 8 Introduction to Capital Budgeting

Introduction to Capital Budgeting

In general, Capital Budgeting consists of deciding on what to do with the firm's money. The focus in capital budgeting is about choosing the course of action that maximizes the value of the firm. To do this, managers use a number of tools to evaluate the Cash Flows they expect to get in the future from potential investments. What they’re interested in are the incremental cash flows associated with the proposal(s) under consideration:

• Incremental cash flows are the ones that will occur if the project is undertaken, but won’t occur otherwise
• Other cash flows are not relevant to the analysis (they are sunk or otherwise not relevant)

Overview of the Capital Budgeting Process
The general approach in the capital budgeting process is to:

1. Identify projects that look promising
2. Forecast the incremental cash flows associated with the projects
3. Evaluate the projects using one or more capital budgeting decision rules