capital budgeting

Dictionary of Accounting Terms for: capital budgeting
capital budgeting

process of making long-term planning decisions for capital investments. There are typically two types of investment decisions: (1) Selecting new facilities or expanding existing facilities. Examples include: (a) investments in long-term assets such as property, plant, and equipment; and (b) resource commitments in the form of new product development, market research, refunding of long-term debt, introduction of a computer, etc. (2) Replacing existing facilities with new facilities. Examples include replacing a manual bookkeeping system with a computerized system and replacing an inefficient lathe with one that is numerically controlled. As such, capital budgeting decisions are a key factor in the long-term profitability of a firm. To make wise investment decisions, managers need tools at their disposal that will guide them in comparing the benefits and costs of various investment alternatives. Many techniques used for evaluating investment proposals are widely available. They include payback, accounting rate of return, Internal Rate of Return, and the Net Present Value method.

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