The process of planning expenditures on assets whose cash flows are expected to extend beyond one year is known as ________.
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A. B. C. D. E.B
Capital Budgeting is defined as the process of planning expenditures on assets whose cash flows are expected to extend beyond one year.
The correct answer to the question is B. Capital Budgeting.
Capital budgeting is the process of planning and evaluating long-term investment decisions. It involves analyzing and selecting projects or assets that are expected to generate cash flows over a period of time exceeding one year. The objective of capital budgeting is to allocate financial resources to projects that will maximize the value of the firm.
Capital budgeting involves several steps:
Identification of potential projects: In this step, management identifies various investment opportunities or projects that are available for consideration. These projects may include the acquisition of new assets, expansion of existing facilities, research and development initiatives, or any other long-term investment.
Evaluation of cash flows: Once potential projects are identified, the next step is to estimate the cash inflows and outflows associated with each project over its useful life. Cash inflows are the expected revenues or cost savings generated by the project, while cash outflows represent the initial investment and ongoing expenses such as operating costs, maintenance, and taxes.
Time value of money considerations: Capital budgeting recognizes the time value of money, which means that a dollar received in the future is worth less than a dollar received today. Therefore, cash flows occurring in different periods are adjusted by discounting them to their present value using an appropriate discount rate. This allows for a fair comparison of the cash flows across different projects.
Capital budgeting techniques: Various capital budgeting techniques are used to evaluate the attractiveness of investment projects. Some commonly used methods include:
Net Present Value (NPV): NPV calculates the present value of cash inflows minus the present value of cash outflows. A positive NPV indicates that the project is expected to generate value and should be accepted, while a negative NPV suggests the project is expected to destroy value and should be rejected.
Internal Rate of Return (IRR): IRR is the discount rate at which the NPV of a project becomes zero. It represents the project's rate of return or the breakeven discount rate. If the project's IRR is higher than the required rate of return or hurdle rate, the project is considered acceptable.
Payback Period: Payback Period is the length of time required to recover the initial investment in a project. Projects with shorter payback periods are generally considered more favorable as they provide faster cash recovery.
Profitability Index (PI): PI is calculated by dividing the present value of cash inflows by the present value of cash outflows. It measures the benefit per unit of investment and helps rank projects in terms of their profitability.
Selection and monitoring of projects: Based on the evaluation of cash flows and the application of capital budgeting techniques, management selects the projects that align with the organization's strategic objectives and financial constraints. Once the projects are approved and implemented, they are closely monitored to ensure they are delivering the expected benefits and meeting financial targets.
In summary, capital budgeting is a crucial financial management process that involves planning and evaluating long-term investment decisions. It helps organizations allocate resources to projects that are expected to generate positive cash flows over an extended period, thereby maximizing the value of the firm.