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Capital budgeting is a technique that examines the investment and spending of a business. In addition, capital budgeting ensures productivity is mediated so that the decisions concerning the satisfactoriness of the scheme can be taken (Carey et al., 2014). The process normally starts with the assessment of the cash outflow, then recognizing the scheme life span and the cash inflows. The idea of time value money has to be incorporated on the cash inflows and then the inflow and outflow has to be contrasted to arrive at the productivity of a scheme (Atrill, & McLaney, 2017).
There are a number of tools used in capital budgeting process. These tools comprise of net present value, internal rate of return, the accounting rate of return, profitability index and the payback period. For instance, if projects in an institution are mutually exclusive, then managers should select the project with highest positive net present value among the alternatives (Atrill, & McLaney, 2017). On the other hand, if a project appears singly, if it generates positive net present value it should be selected. Projects having higher Internal rate of return and the accounting rate of return than the cost of capital have to be selected. Furthermore, projects having shorter payback period also have to be chosen (Carey et al., 2014).
The above techniques of capital budgeting can be used for the downsizing or expansion of a trade. First, the organization must assess the amount of funds that it must spend (Atrill, & McLaney, 2017). Then, the inflows from downsizing or expansion of the business have to be computed. The present value of the cash inflows has to be itemized and then the productivity of the business has to be computed. This will assist to recognize whether it is lucrative to downsize or expand the trade (Carey et al., 2014).
References
Atrill, P. and McLaney, E. (2017). Accounting and finance for non-specialists. 10th ed. Harlow: Pearson Education Limited.
Carey, M., Knowles, C. and Towers-Clark, J. (2014). Accounting. 2nd ed. Oxford: Oxford University Press. (Carey et al., 2014)
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