Capital Budgeting
Capital budgeting involves the planning and evaluating of long-term investments. Examples of long-term investments are buying long-term assets, acquisitions of other companies, starting or introducing a new product line, etc.
Managers face challenges of making appropriate capital decisions pertaining to long-term investments. This requires managers to understand how to perform some quantitative and qualitative analyses before making informed decisions.
Making long-term investment decisions are so important that if not properly executed, a company may lose huge amounts of money or subsequently face liquidation. Thus, there is a need for understanding and making a decision that will foresee success of such investments. It is also important to note that managers use both quantitative and qualitative analyses to make capital budgeting decisions.
Quantitative analysis includes using financial figures to analyze the scenarios or alternatives of a given project or investment that is being pursued. Some of the quantitative measures that managers use in capital management decisions include payback period, Return on Investment (ROI) and net present value.
Qualitative analysis includes using nonfinancial figures to understand and make decisions of the given project or investment. Some of the qualitative analysis procedures used includes the political environment, economic environment, competition in the industry, etc.
Because the nature of qualitative analysis is so dynamic, throughout this capital budgeting chapter, we will discuss the quantitative analysis methods.
The three common methods used in capital management are: