Capital budgeting

Capital Budgeting

Capital budgeting refers to the process that companies use to make critical decisions where long-term investments are involved.

The CAPM formula is used to determine the required appropriate return rate for assets or the discount rate. The discount rate is the return of future cash flows and it is the rate at which an asset should actually be discounted with given the risk level of an asset. According to CAPM, the higher the systematic risk in a company as provided by beta the higher the return a company should invest more in the firm. For instance if Camp has been determined to be 15% then the IRR should be higher than 15% to be acceptable (Garrison, Noreen & Brewer, 2010).

The Net Present Value is the sum of the future cash flows that an investment earns. The NPV should be positive if a project should be accepted.