FINANCIAL POLICY
Capital Budgeting

Capital Budgeting

In the process of maximizing wealth, both households and corporations must invest An investment is defined as a change in the investor’s stock of Real assets Financial, or derivative assets

Capital Budgeting
Capital budgeting is defined as  The process of planning expenditures on assets whose cash flows are expected to extend beyond one year By convention, the process is referred to as financial asset valuation when it deals with financial, or derivative assets, and as Capital Budgeting when it deals with real assets

Capital Budgeting
Comparing processes: Real Assets
Determine the cost of the investment project Estimate expected cash flows including salvage value Determine the riskiness of the cash flows Determine cost including risk premium Estimate the NPV of cash flows Compare NPV of inflows and outflows

Financial Assets
Determine the price that must be paid for the asset Determine future interest or dividend payments and expected sales price Determine the riskiness of the cash flows Determine cost including risk premium Estimate the NPV of future interest or dividend payments Compare NPV of inflows and outflows

Capital Budgeting

The corporation’s long-run targets concerning its competitive edge, survival and growth are spelled out in its Strategic Business Plan The strategic business plan is therefore the source of a number of potentially profitable investment opportunities that can be translated into a set of capital expenditure proposals

Capital Budgeting
Capital expenditure proposals will, normally, be related to the following objectives: 1.Replacement to maintain current productive capacity) 2.Replacement to reduce cost, or introduce technological innovations 3.Expansion of productive capacity 4.Expansion into new products or markets

5.Safety/environment

Capital Budgeting Decision Rules
The corporation’s capital expenditure proposals are subsequently analyzed