Finance: Capital Markets, Financial Management, and Investment Management

CHAPTER 13

Capital Budgeting: Process and Cash Flow Estimation

Companies continually invest funds in assets, and these assets produce income and cash flows that the company may then either reinvest in more assets or pay to the owners. These assets represent the company’s capital. Capital is the company’s total assets, including both tangible and intangible assets. These assets include physical assets (such as land, buildings, equipment, and machinery), as well as assets that represent property rights, such as accounts receivable, securities, patents, and copyrights. When we refer to capital investment, we are referring to the company’s investment in its assets, where the term “capital” also has come to mean the funds used to finance the company’s assets and, in some contexts, refers to the sum of equity and interest-bearing debt.

Capital budgeting decisions involve the long-term commitment of a company’s scarce resources in capital investments. These decisions play a prominent role in determining whether a company will be successful. The commitment of funds to a particular capital project can be enormous and may be irreversible. Whereas some capital budgeting decisions are routine decisions that do not change the course or risk of a company, there are strategic capital budgeting decisions that will either have an impact on the company’s future market position in its current product lines or permit it to expand into a new product line in the future

The company’s capital investment ...