Definition of Capital Budgeting
Capital budgeting is a tool of investment appraisal that considers various techniques to evaluate the decision of acceptance or rejection of an investment in a long-term asset.
Three techniques of Capital Budgeting:
Capital budgeting includes normally three techniques to assess that a long-term investment is worthwhile or not.
1. Pay Back Period: I this method we check the approximate time period in which the investment amount is fully recovered.
2. Net Present Value: This method is used to assess that either a project will result in positive cash flows or negative cash flows. The cash flows in this method are discounted at an appropriate discount rate to reach the present value of cash inflows and then the investment is deducted from the present value.
3. IRR: Internal rate of return is a measure that assesses the real annual growth rate of the cash flows. If the IRR is higher than the discount rate the project is accepted.