Lesson 37 - Advanced Accounting Course

Lesson 37: Capital Budgeting Decisions and Long-Term Investment Strategies

💡 What is Capital Budgeting?

Capital budgeting is the process companies use to evaluate big investment projects — like building a new factory, buying equipment, or launching a new product line.

🧠 The main question is:

“Will this investment bring more money in the future than it costs today?”

🏗️ Examples of Capital Investments

• 🏢 Building a new plant
  
  

• 💻 Buying new technology or machinery
  
  

• 📦 Launching a new product line
  
  

• 🌍 Expanding into new markets
  
  

These are long-term decisions — they affect the company for many years!

🎯 Key Capital Budgeting Methods

🧮 1. Net Present Value (NPV) 

If NPV is:

• ✅ Positive → Project adds value
  
  

• ❌ Negative → Project destroys value
  
  

📘 Example:

• Invest $10,000
  
  

• Future cash flows (present value): $12,000
  
  

• ➕ NPV = $12,000 – $10,000 = $2,000
  
  

👉 Accept the project!

📈 2. Internal Rate of Return (IRR)

The IRR is the discount rate that makes NPV = 0.
If the IRR is higher than your required rate (e.g. 10%), the project is profitable.

📘 Example:

• IRR = 14%
  
  

• Required return = 10%
  👉 Accept the project!
  
  

⏱️ 3. Payback Period

How many years it takes to get back the money you invested.

Example:

• Investment = $10,000
  
  

• Yearly return = $2,500
  
  

• Payback = $10,000 ÷ $2,500 = 4 years
  
  

👉 Good for quick decision making, but doesn’t account for profits after the payback.

💰 4. Profitability Index (PI)

If PI > 1 → The investment is worth more than it costs
If PI < 1 → Not worth it!

📊 Summary Table: Capital Budgeting Tools

🧠 Strategic Thinking: Long-Term Investment Strategy

Good companies don’t just look at numbers — they also consider:

• 🌱 Growth potential
  
  

• 💼 Strategic fit (Does this align with company goals?)
  
  

• 🔁 Sustainability (Can it last over time?)
  
  

• 🛠️ Risk management (What if things go wrong?)
  
  

📘 Recap