In This Chapter
Introducing the theory of capital budgeting
Putting it all together
Calculating the rate of return on capital
Thinking about risk
Relating capital budgeting to QuickBooks
The challenge for any business is allocating capital, or money. Although you have limited amounts of capital, your ideas and opportunities are often unlimited.
Capital budgeting, in a nutshell, helps you to sift through all these ideas and opportunities. Capital budgeting lets you answer questions like the following: Should I replace that key piece of machinery that we use in the factory or get a new delivery truck? Should we buy the building our offices are in? Or should we purchase that competitor's operation because it's for sale?
Capital budgeting boils down to the idea that you should look at capital investments (machinery, vehicles, real estate, entire businesses, yard art, and so on) just as you look at the CDs (certificates of deposits) that a bank offers.
Don't worry — you actually already know how to do this. When you buy a bank CD, you essentially look at one big thing and then a couple of small things in order to decide whether a CD makes sense. The big thing is the interest rate. The two small things are the CD maturity and the risk. In the next couple of sections, I talk a bit about all three things because they apply so neatly to the problem and challenge of capital budgeting.