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Explanation for Capital Budgeting

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In your own words, explain capital budgeting. Why is it important to a company's long-term success? Provide an example of poorly performed capital budgeting. How does this affect a company's long-term success?

Why is capital budgeting part of a company's long-term strategic planning process? What are the pros and cons of these methods:


o Simple payback

o IRR.

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The solution provides an explanation for capital budgeting.

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Explain capital budgeting:

Ekeha (2010) provides that capital budgeting deals with large investments in long term assets and it is used to make investment decisions. Capital budgeting is termed as the process through which a firm examines whether a long term investment is worth pursuing. The investment's cash inflows and outflows over its lifetime are used to determine if returns received are in line with target benchmark. Techniques used in capital budgeting include net present value, internal rate of return, payback period, accounting rate of return, profitability index models and others (Cooper et al, 2002).

Why capital budgeting is important for long term success:

Capital budgeting affects long term success of a business because the investments have long term consequences on the business as investments have significant impact on future cash flows and risk associated with the cash flows (Ekeha, 2010). A firm utilizes capital budgeting to make investments decisions and this decisions are aimed at increasing shareholders' wealth and thus capital budgeting is critical for business success. According to Szpiro & Dimnik (1996), capital budgeting is important since decisions made determine a firm's structural cost drivers and ...

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