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Define capital budgeting. Examine how the optimum level of capital is determined.

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Capital Budgeting
Ideally, businesses should pursue all projects and opportunities that enhance shareholder value. However, because the amount of capital available at any given time for new projects is limited, management needs to use capital budgeting techniques to determine which projects will yield the most return over an applicable period of time.

Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period.

Many formal methods are used in capital budgeting, including the techniques such as
  • Accounting rate of return
  • Net present value
  • Profitability index
  • Internal rate of return
  • Modified internal rate of return
  • Equivalent annuity
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