Capital Budgeting Process

1.   Capital budgeting is the process of identifying, analyzing and selecting investment projects whose returns (cash flows) are expected to extend beyond one year.

2. Specially, capital budgeting involves:

      a. Generating investment project proposals consistent with the firm’s strategic objectives;

      b. Estimating after tax incremental operating cash flows for the investment projects;

      c. Evaluating project incremental cash flows;

      d. Selecting projects based on a value maximizing acceptance criterion; and

      e. Continually evaluating implemented investment projects and performing pposaudits for completed projects.

3. Because cash, not accounting income, is central to all decisions of the firm, we express the benefits we expect to receive from a project in-terms of cash flows rather than income flows.

4. Cash flows should be measured on an incremental, after tax basis. In additional, our concern is with operating, not financing flows...

5. Tax depreciation under the modified accelerated cost recovery system(MACRS)has a significant effect on the size and pattern of cash flows is the presence of salvage value (disposable/reclamation costs) and projects driven changes in working capital requirements.

6. It is helpful to place project cash flow into three categories based in timing:

      a. The initial cash outflow;

      b. Interim incremental net cash flows, and

      c. The terminal-year incremental cash flow.