Introduction

Capital:
Capital is a term for financial assets, such as funds held in deposit accounts and/or funds
obtained from special financing sources. Capital can also be associated with capital assets of a
company that requires significant amounts of capital to finance or expand.
Capital can be held through financial assets or raised from debt or equity financing. Businesses
will typically focus on three types of business capital: working capital, equity capital, and debt
capital. In general, business capital is a core part of running a business and financing capital
intensive assets.
Capital assets are assets of a business found on either the current or long-term portion of the
balance sheet. Capital assets can include cash, cash equivalents, and marketable securities as well
as manufacturing equipment, production facilities, and storage facilities.

Budgeting:
A budget is an estimation of revenue and expenses over a specified future period of time and is
usually compiled and re-evaluated on a periodic basis. Budgets can be made for a person, a
family, a group of people, a business, a government, a country, a multinational organization or
just about anything else that makes and spends money. At companies and organizations, a budget
is an internal tool used by management and is often not required for reporting by external parties.

What is Capital Budgeting:

Capital budgeting is the process a business undertakes to evaluate potential major projects or
investments. Construction of a new plant or a big investment in an outside venture are examples
of projects that would require capital budgeting before they are approved or rejected.

As part of capital budgeting, a company might assess a prospective project's lifetime cash
inflows and outflows to determine whether the potential returns that would be generated meet a
sufficient target benchmark. The process is also known as investment appraisal.

businesses would pursue any and all projects and opportunities that enhance shareholder value.
However, because the amount of capital any business has available for new projects is limited,
management uses capital budgeting techniques to determine which projects will yield the best
return over an applicable period.

Some methods of capital budgeting companies use to determine which projects to pursue include
throughput analysis are as follow:
 1. Payback Period:
This method favors earlier cash flows and selects projects based on the time it takes to recover
the firm’s investment. Weaknesses in this method include the facts it does not consider:

• Cash flows after the payback period

• The time values of money

Use this method to select from projects with similar rates of return and that were also
evaluated using a discounted cash flow (DCF) method.

2. Net Present Valve Method:

Base the Net Present Value (NPV) Method on the time value of money. It is a popular DCF
method. The NPV Method discounts future cash flows (both in- and out-flows) using a minimum
acceptable cost of capital (usually based on the weighted average cost of capital or WACC,
adjusted for perceived risk). Refer to this as the “hurdle rate.” NPV is the difference between the
present value of net cash inflows and cash outflows. And a $0 answer implies that the project is
profitable and that the firm recovered its cost of capital.

3.Internal Rate Of Return:

The Internal Rate of Return (IRR) Method is based on the time value of money. It calculates the
interest rate that equates the present value of cash outflows and cash inflows. This calculated rate
of return is then compared to the required rate of return, or hurdle rate, to determine the viability
of the capital projects.

4. Profitibility index:

It is the ratio of the present value of future cash benefits, at the required rate of return to the
initial cash outflow of the investment. It may be gross or net, net being simply gross minus one.
The formula to calculate profitability index (PI) or benefit cost (BC) ratio is as follows.

PI = PV cash inflows/Initial cash outlay