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Capital expenditure decisions

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Besides the rate of return, what additional factors should a firm consider in its capital expenditure decisions? Why is it important for a firm to conduct capital budgeting analysis under conditions of both certainty and uncertainty? What are some challenges that an analyst might encounter in applying capital budgeting analysis to for-profit versus nonprofit organizations?

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Besides the rate of return, what additional factors should a firm consider in its capital expenditure decisions?
The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. The firm's investment decisions would generally include expansion, acquisition, modernization and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.

Decisions like the change in the methods of sales distribution, or an advertisement campaign or research and development programs have long-term implications for the firm's expenditures and benefits, and therefore, they should also be evaluated as investment decisions. Several different procedures are available to analyze potential business investments. Some concepts are better than others when it comes to reliability but all provide enough information to get the general scope of the investment. The five procedures that provide useful information are the Net present Value (NPV), the Payback Rule, the Average Accounting Return (AAR), the Internal Rate of Return (IRR), and the Profitability Index (PI). These procedures will help rank the projects from the greatest investment to the worst.

Thus capital budgeting has following characteristics:

The exchange of current funds for future benefits.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of years.

Criteria of selection of Capital Budgeting project:

It should maximize the shareholders' wealth.
It should consider all cash flows to determine the true profitability of the project.
It should provide for an objective and unambiguous way of separating good projects from bad projects.
It should help ranking of projects according to their true profitability.
It should recognize the fact that bigger cash flows are preferable to smaller ones and early cash flows are preferable to later ones.
It should help to choose among mutually exclusive projects that project which maximizes the shareholders' wealth.
It should be a ...

Solution Summary

This explains the Capital expenditure decisions

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