What you will learn to do: Identify the essential elements of a capital budgeting decision

In accession capital projects, we have a few essential elements we need to understand in detail:

• Time constraints
• Time Value of Money
• Discount Rates
• Depreciation and Taxes

In order to perform the more sophisticated but informative analysis needed to make capital decisions, we need to take into account the risk in terms of the hurdle or discount rate, along with some kind of time horizon that the project fits into. It’s almost impossible to make a decision without some kind of beginning and ending time frame. In addition, in business especially, we need to take depreciation and taxes into account because investments in capital assets (other than land) do provide some tax benefits that offset income and therefore reduce taxes. Even though that is not technically a “cash inflow”, it reduces cash outflows in the form of taxes and is often called a tax “shelter” or tax “shield”.

When you are done with this section, you will be able to:

• Understand the time horizon related to capital investments
• Understand the time value of money
• Understand discount rates and how they are used in capital budgeting
• Understand how long-term assets are depreciated and how that affects taxes

Learning Activities

The learning activities for this section include the following:

• Reading: Time Constraints
• Self Check: Time Constraints
• Reading: Time Value of Money
• Self Check: Time Value of Money
• Reading: Discount Rates
• Self Check: Discount Rates
• Reading: Taxes and Depreciation
• Self Check: Taxes and Depreciation