To select the best long-term investments, firms rely on a process called ‘capital budgeting’. There is typically a lot of uncertainty around major investments, and the techniques of capital budgeting are a useful way of reducing that uncertainty and clarifying the likely returns on the investment. There are several different techniques, each with their own pros and cons.
When to use it
- To decide whether a firm should make a capital investment.
- To evaluate the relative attractiveness of several potential projects.
Capital budgeting as a tool has been around at least since humans began farming. Historian Fritz Heichelheim believed that capital budgeting was employed in food production by about 5,000 BC. He noted ...