7.1 : Introduction to Capital Budgeting

Capital budgeting is selecting which long-term fixed assets to invest in to maximize shareholder value. These decisions significantly impact a firm's value, making capital budgeting one of the most crucial financial functions.

It involves decisions about investing in fixed assets to generate future profits. Questions like whether an automobile manufacturer should buy a piece of new machinery for the assembly line, an airline should add a plane, or a hotel chain should build a new location are examples of capital budgeting decisions. These investments are essential for companies to develop new products, improve existing ones, and enter new markets.

The process involves evaluating potential investments by estimating the associated cash flows' size, timing, and risk. The finance department collaborates with various departments, including marketing, operations, accounting, human resources, and economics, to compile these cash flow estimates. This collaborative effort aims to develop a portfolio of investment projects that collectively maximize the firm's value.

The goal is to determine if the project will generate sufficient cash flow to cover the initial costs and contribute to the company's growth and competitiveness.