Chapter 4: Capital Budgeting Decisions

Should I make an investment?

Capital budgeting should not be confused with budgeting for capital; the latter is part of an enterprise's planned spending on capital assets after they have first been approved through the capital budgeting exercise. Capital budgeting makes certain assumptions about incremental cash flows—such as sales growth and cost inflation—to build a financial model that generates the following metrics: NPV, IRR, and payback period. Of these measures, NPV and IRR use discounted cash flows (DCF), while the payback period is not discounted. The payback measure is provided primarily for those who are not comfortable with the concept of the time value of money (i.e., DCF), which typically include non–financially trained decision-makers (such as those with backgrounds in Operations Management or Human Resources, for example).