Capital Budgeting Techniques

Abstract

There are several techniques that are used in practice to evaluate capital budgeting proposals. These include the payback and discounted payback techniques, net present value technique, profitability index technique, internal rate of return technique, and modified internal rate of return technique. While used in practice, some of these techniques are limited in their ability to help managers identify proposed capital projects that are profitable and are not necessarily consistent with maximization of shareholder wealth. Moreover, where capital rationing exists, some techniques give conflicting rankings of the relative attractiveness of capital projects. Keywords: capital budgeting techniques; net present value (NPV); internal rate of return (IRR); payback period; discounted payback period; modified internal rate of return (MIRR); profitability index; mutually exclusive projects; independent projects; capital rationing; cost of capital; required rate of return (RRR); crossover discount rate; hurdle rate