Capital budgeting

Capital budgeting is the process of evaluating long-term investments by estimating their costs, expected cash flows, risks, and effects on an organization’s value.

Net present value: Net present value is the difference between the present value of expected cash inflows and the present value of investment costs. It estimates how much value an investment adds after discounting future cash flows.
Cash flow: Cash flow is the movement of money into and out of an entity over time. Project cash flows, rather than accounting earnings alone, drive most investment valuations.
Capital rationing: Capital rationing is the restriction of investment spending when an organization cannot fund every worthwhile project. It makes project ranking essential when budgets or financing capacity are constrained.
Accounting rate of return: The accounting rate of return measures average accounting profit as a proportion of an investment’s book value or cost. Unlike discounted cash-flow methods, it uses accounting profit and does not discount for timing.
Shareholder value: Shareholder value is the economic value accruing to a company’s owners through its equity interest. Value-based appraisal favors investments expected to increase owners’ wealth, subject to the firm’s objectives.
Internal rate of return: The internal rate of return is the discount rate that makes a project’s net present value equal zero. It expresses a project’s expected return as a rate that can be compared with a required return.
Time value of money: The time value of money is the principle that money available now is worth more than the same amount received later. It explains why future project returns must be discounted before comparison with current costs.
Replacement project: A replacement project is an investment that substitutes a new asset for an existing one. Its appraisal weighs new operating benefits against purchase costs and the value of retiring the old asset.
Modified internal rate of return: Modified internal rate of return calculates a project return using specified financing and reinvestment rates. It addresses the multiple-rate and reinvestment assumptions that can complicate ordinary internal rate of return.
Agency problem: An agency problem arises when an agent’s interests or actions diverge from those of the principal they represent. Managers may favor projects that serve their incentives rather than maximize organizational value.

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