Wize University Introduction to Finance Textbook > Capital Budgeting
Introduction to Capital Budgeting
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What is Capital Budgeting
Capital budgeting is the process of evaluating potential investments or projects to determine whether or not they should be approved.
Examples of Capital Budgeting Decisions
- Constructing a new factory
- Acquiring or renovating a building
- Expanding business into a new geographic market
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Cost of Capital
When a firm evaluates a possible investment, the cost of capital is the minimum required return on investment that would be needed to justify a capital investment.
What is the Cost of Capital (r)
- The cost of a company's funds raised through debt and equity.
- Under normal circumstances, a firm's capital investments should bring in at least the cost of capital otherwise the firm will lose money.
Risk-Adjusted Cost of Capital
- The firm's cost of capital should be adjusted for the risk of the project by adding a risk premium when needed.
- If the investment's risk is similar to the overall risk of the company, a risk premium is not needed.