Managerial Economics For Dummies

Chapter 16

Using Capital Budgeting to Prepare for the Future

In This Chapter

Preparing for capital investments

Determining capital’s cost

Choosing the best capital investments

Purchasing machinery and equipment and building factories require spending today in order to receive future revenue. Thus, capital budgeting is one of the most important and yet uncertain decision-making areas because it’s critically influenced by time.

Capital budgeting decisions require a substantial amount of forecasting — I hope you have your crystal ball or Magic 8 ball handy. Biased or poorly developed forecasts adversely affect the quality of investment decisions. Therefore, techniques for evaluating capital investment projects have limited value in the absence of unbiased, well-developed forecasts.

In this chapter, I show you the critical components for evaluating alternative investment projects and selecting from them. That process includes understanding critical aspects of estimating future cash flows and procedures for determining the cost of capital. Understanding these critical components provides the foundation for comparing and evaluating alternative investment projects.

Investing in Capital ...