Capital Budgeting

Capital Budgeting

The process a firm uses to evaluate which projects to pursue based on maximizing value to owners or shareholders.

Net Present Value (NPV)

The present value of all cash flows of a project discounted at the appropriate opportunity cost of capital.

Investment Evaluation Techniques

Methods used to assess various capital budgeting alternatives, including NPV and IRR.

Internal Rate of Return (IRR)

The discount rate at which the net present value of a project equals zero.

Profitability Index (PI)

The net present value of future cash flows generated by a project divided by the required investment.

Equivalent Annual Costs (EAC)

A framework to compare costs over different time horizons, also known as Equivalent Annual Annuity (EAA).

Cash Flow Forecasting

The process of estimating the amount and timing of future cash flows for a project.

Opportunity Cost of Capital

The return rate that could be earned on an investment of similar risk.

Cash Flow

Money that is received and spent by a business in a given period.

Discounted Cash Flow

A valuation method used to estimate the value of an investment based on its expected future cash flows.

Positive NPV

An indicator that a project is expected to generate value and should thus be accepted.

Investment Alternatives

Different projects or investments a firm might consider for capital budgeting.

Cash Flow Patterns

The timing and amounts of future cash flows generated by a project.

Mutually Exclusive Projects

Projects where the acceptance of one project means that the other cannot be accepted.

Modified Internal Rate of Return (MIRR)

A variation of IRR that assumes positive cash flows are reinvested at the opportunity cost of capital.

Capital Rationing

The practice of limiting the amount of new investments or projects to undertake, typically due to limited resources.