This is “Capital Budgeting Decision Making”, chapter 13 from the book Finance for Managers (v. 0.1).
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Life is full of choices. Should we spend our money or save it? Should we buy a new DVD or a book? Should we loan money to our unemployed cousin? All of these examples involve a tradeoff; because we did one thing, we can’t do another. Businesses face the same type of decisions. Should we buy a new machine or fix the old one? Should we build the new plant in Kansas or in Mexico? To help decide which project to do, we need a framework with which to evaluate them.
Companies, like people, have many goals but limited resources. If the objective is to maximize stakeholder value, how do we choose the project with the greatest return? Capital budgeting decision making techniques are a series of analyses to help us decide which project is best. To decide which project will add the most value to the company, managers use capital budgeting techniques. This way, decisions are made based on financial data, instead of political pressure or gut instinct.