Capital Budgeting Techniques
Capital Budgeting or investment appraisal is a process of analyzing long-term investment decisions of businesses. The objective of capital budgeting is to determine the feasibility of long-term investments, for example, purchase or replacement of machinery, introducing new product line or other mega projects.
Most Commonly used capital budgeting techniques are:
- ARR – Accounting Rate of Return
- Payback Period
- Discounted Payback Period
- NPV – Net Present Value
- IRR – Internal Rate of Return
- Profitability Index
Here we will see what other factors are affecting individuals or firms choices of capital budgeting methods when they evaluate projects.
- Individuals as compare to businesses, usually prefer to go with payback period method results while evaluating their personal investments.
- Asian and European countries prefer payback period method over NPV and IRR for evaluating their projects.
- Larger companies more likely to use capital budgeting techniques that involve discounted cash flows. E.g. NPV and IRR
- Private Ltd. Companies usually use payback period method while public limited companies use discounted cash flow methods.
- The higher the level of education of management, more likely to use discounted cash flow methods.