Steps of Capital Budgeting

Learning Outcomes

  • Discuss the steps in the capital budgeting process

So let’s say our supervisor comes to us with the following situation: We need to add a product line, and we have three options. Each option requires capital outlay including new equipment and manufacturing space. They all require a quite substantial initial investment. Where do we start?

Watch It

The first step will be a screening decision. In this step we will look at all of the projects, and determine whether they meet the company’s basic guidelines for consideration. Our company, may for example, require a 20% rate of return on a new investment before it will even be considered as an option. Once we screen all of the potential options, if any meet this guideline, we can move on the the preference decision.

The preference decision takes all of the projects that meet the screening process and then decide which to choose. Perhaps, we have three machines available that would all provide us with a 20% rate of return on the investment each year. Now, we need to decide between the three machines, which one to pick!

We can use a variety of methods once we get to this point to make our choice!

Practice Questions