Capital Budgeting: An Introduction

Chapter 10: Capital BudgetingTheddy B.Feonale (392047)

Tegar Satya Putra (392046)

Capital Budget

List of planned investment

in long term assets

Capital Budgeting :

Whole processes of

analyzing projects and

deciding which ones to

be accepted.

Long Term AssetsProjected

Expenditure

Formula :

DISCOUNTED PAYBACK

Three other issues in capital budgeting are discussed in

this section:

(1) how to deal with mutually exclusive projects whose lives

differ;

(2) the potential advantage of terminating a project before

the end of its physical life; and

(3) the optimal capital budget when the cost of capital rises

as the size of the capital budget increases.

optimal capital budget is defined as the set of projects

that maximizes the value of the firm.

Two problems arise in real world:

(1)The cost of capital might increase as the size of the

capital budget increases, making it hard to know the

proper discount rate to use when evaluating projects;

(2) sometimes firms set an upper limit on the size of their

capital budgets, which is also known as capital rationing

Why capital rationing is quite common:

1. Reluctance to issue new stock

2. Constraints on nonmonetary resources

3. Controlling estimation bias