Capital Budgeting - Research Paper Example

Firstly, capital expenditures require large expenditures of funds. Secondly, firms must find out the best approach to repay and raise these funds. Third, majority of the decisions of capital budgeting include a long-term assurance. Finally, the timing of the capital budgeting decisions is significant. When the firms raise large amount of funds, they need to consider the financial markets more attentively because the cost of capital is directly related to the current interest rate. In short, capital budgeting is the means of conducting cost-benefit analysis (Scribd, 2011).

The requirement for important information and analysis of the alternatives of capital budgeting have inspired the development of a sequence of models to help firms in making the "best" allocation of resources. The extent to which the capital budgeting plays a significant role within the firm is determined by the following factors: The capital budgeting process must take into consideration the nature of investment proposals, for example, mutually exclusive or independent proposals. Individual proposals are those which are calculated individually and more than one proposal can be accepted or rejected.

There are a number of capital budgeting techniques that firms can employ. These techniques do not always lead to the same accept-reject decision, thus it is essential to make a decision of what a good capital budgeting technique looks like. A perfect Capital Budget technique should be: There are two types of capital budgeting techniques namely sophisticated techniques and unsophisticated techniques. Although both the techniques use cash flows as their initial point to get to the result from which the ultimate decision can be taken, the main difference between the two is that sophisticated techniques take time value of money into account whereas the same is not in case of unsophisticated techniques.

Sophisticated techniques include