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CAPITAL BUDGETING Capital Expenditures A expenditure that generates a cash flow benefit for more than one year is called a capital expenditure Some examples include the purchase of new equipment expansion of production facilities buying another company acquiring new technologies or launching a research development program A capital expenditure involves large cash outlays with implications on future values of a company Once committed to making a capital expenditure it is sometimes difficult to back out In this case further analyzing and evaluating capital expenditures is needed The Three Stages of Capital Budgeting Analysis Capital Budgeting Analysis is a process of evaluating how to invest in capital assets which are assets that provide cash flow benefits for more than one year It has been said that how money today is spent determines what the value will be tomorrow Focusing attention on present values so that expenditures today influence values in the future is what most people do A approach in looking at present values of projects is discounted cash flows or DCF which is said to be to narrow to evaluate a project The three stages within Capital Budgeting Analysis are 1Decision Analysis for Knowledge Building 2Option Pricing to Establish Position 3Discounted Cash Flow DCF for making the Investment Decision Decision Analysis Decision making is becoming complex in todays world because of uncertainty Capital projects involve several variables and possible outcomes An example maybe estimating cash flows associated with a project that involves working capital requirements project risk tax considerations expected rates of inflation and disposal values Understanding existing markets that forecast project revenues assess competitive impacts of the project and determine the life cycle of the project are very important Capital project also involves production operating costs additional overheads capacity utilization and start-up costs Managing capital projects can be done by simply looking at the numbers and the entire decision and determining all variables
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