UNIT IV

Mathematics of Capital Budgeting and Depreciation

1. Capital Budgeting

2. Depreciation and Depletion

Unit IV Summary

List of Formulas

Exercises for Unit IV

1 Capital Budgeting

One of the most crucial decisions made in the business world is an investment decision, where investors have to choose the most worthy project to fund. It refers to the highest responsibility of the decision makers to see if a certain capital fund should be allocated in the next budget as a specific investment project. Given that alternative investment opportunities differ in many aspects, such as the level of risk associated with them, and their capacities to yield future returns, the criteria for choice would be to assess carefully the proposed alternatives, and select the potentially most profitable. Capital expenditure is an outlay of funds which a firm would rely on to bring enough returns to cover and exceed the initial investment. Therefore, capital budgeting is a process to review, analyze, and select those projects that promise to be the most rewarding in the medium and long runs.

Cash flow analysis is most helpful in determining the profitability of capital. It involves the evaluation and comparison of two flows: the cash outflows, which consist mainly of the initial capital funds allocated to an investment project as well as the capital expenditures throughout the life of assets in their productive process; and the cash inflows, which consist primarily of estimates of the returns ...

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