Article 14386178327161. INTRODUCTION#cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10
Capital budgeting is the process that companies use for decision making on capital projects—those projects with a life of a year or more. This is a fundamental area of knowledge for financial analysts for many reasons.
First, capital budgeting is very important for corporations. Capital projects, which make up the long-term asset portion of the balance sheet, can be so large that sound capital budgeting decisions ultimately decide the future of many corporations. Capital decisions cannot be reversed at a low cost, so mistakes are very costly. Indeed, the real capital investments of a company describe a company better than its working capital or capital structures, which are intangible and tend to be similar for many corporations.
Second, the principles of capital budgeting have been adapted for many other corporate decisions, such as investments in working capital, leasing, mergers and acquisitions, and bond refunding.
Third, the valuation principles used in capital budgetin
Article 14386277941882. THE CAPITAL BUDGETING PROCESS#cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10
The specific capital budgeting procedures that a manager uses depend on the manager’s level in the organization, the size and complexity of the project being evaluated, and the size of the organization. The typical steps in the capital budgeting process are as follows:
Step One: Generating Ideas—Investment ideas can come from anywhere, from the top or the bottom of the organization, from any department or functional area, or from outside the company. Generating good investment ideas to consider is the most important step in the process.
Step Two: Analyzing Individual Proposals—This step involves gathering the information to forecast cash flows for each project and then evaluating the project’s profitability.
Step Three: Planning the Capital Budget—The company must organize the profitable proposals into a coordinated whole that fits within the company’s overall strategies, and it also must consider the projects’ timing. Some projects that look good when considered in isolatio
Article 14386388042363. BASIC PRINCIPLES OF CAPITAL BUDGETING#cfa-level-1 #corporate-finance #reading-35-capital-budgeting #study-session-10
Capital budgeting has a rich history and sometimes employs some pretty sophisticated procedures. Fortunately, capital budgeting relies on just a few basic principles. Capital budgeting usually uses the following assumptions:
Decisions are based on cash flows. The decisions are not based on accounting concepts, such as net income. Furthermore, intangible costs and benefits are often ignored because, if they are real, they should result in cash flows at some other time.
Timing of cash flows is crucial. Analysts make an extraordinary effort to detail precisely when cash flows occur.
Cash flows are based on opportunity costs. What are the incremental cash flows that occur with an investment compared to what they would have been without the investment?
Cash flows are analyzed on an after-tax basis. Taxes must be fully reflected in all capital budgeting decisions.
Financing costs are ignored. This may seem unrealistic, but it is not. Most of the time, analysts want to