Explain capital budgeting and identifying the factors that influence a capital budgeting analysis. Also, describe the Capital Asset Pricing Model (CAPM) and indicate how it is used in capital budgeting.
Capital budgeting means the process of determining which potential long term projects can be selected by comparing the discounted cash flow of the projects with the internal rate of return. That is in capital budgeting, the project which gives highest net present value will be selected. Capital budgeting is the process by which the manager has to decide whether to invest the money in a particular project. It is a process of making long term planning decisions for capital investment. The techniques of capital budgeting include pay back method, Net present value method, Internal rate of return method, Benefit cost ratio, Accounting rate of return.
Factors which will be considered in capital budgeting:
1. Rate of Return expected to be received from the projects.
2. Time value of the money i.e., the value of one dollar after the five years or ten years at certain rate of interest.
Capital budgeting and CAPM are explained.