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What is capital budgeting and why is it important to business decisions?

According to Investopedia.com, capital budgeting is important because it creates accountability and measurability. Any business that seeks to invest its resources in a project, without understanding the risks and returns involved, would be held as irresponsible by its owners or shareholders. Furthermore, if a business has no way of measuring the effectiveness of its investment decisions, chances are that the business will have little chance of surviving in the competitive marketplace. Businesses (aside from non-profits) exist to earn profits. The capital budgeting process is a measurable way for businesses to determine the long-term economic and financial profitability of any investment project. 

Discuss how the information should be organized in a capital budgeting process, and who will use the information for decision-making.
 The unique challenges encountered when budgeting for capital assets can be summarized as follows:

The eventual outcome is uncertain.
Large amounts of money are involved.
The investment decision represents a long-term commitment.
The investment decision may be difficult or impossible to reverse.
The capital budgeting process involves calculating one or more of what are called “capital budgeting metrics” and evaluating those metrics alongside the organization’s corresponding financial goals.
What could go wrong with the capital budgeting process?

According to Merritt, cash flow can be a major issue. Even up-front costs, which are more immediate and therefore easier to forecast, are still only estimates at this stage. Overestimate revenue or underestimate costs, and a project that looks profitable could become a money-loser. Underestimate revenue or overestimate costs, and you might end up rejecting a project that would have proved profitable.

Provide an example of a capital budgeting process from an online source and explain the salient points of this example to the class.

In December 2009 ExxonMobil, the world’s largest oil company, announced that it was acquiring XTO Resources, one of the largest natural gas companies in the U.S. for $41 billion. That acquisition was a capital budgeting decision, one in which ExxonMobil made a huge financial commitment. But in addition, ExxonMobil was making a significant investment decision in natural gas and essentially positioning the company to also focus on growth opportunities in the natural gas arena. That acquisition alone will have a profound effect on future projects that ExxonMobil considers and evaluates for many years to come (Investopedia.com).  

CPA Gardens. (n.d.). Capital Budgeting | CPA Gardens. Retrieved fromhttps://www.cpagardens.com/content/capital-budgeting
Investopedia.com. (2012, November 15). Capital Budgeting: The Importance Of Capital Budgeting. Retrieved from https://www.investopedia.com/university/capital-budgeting/importance.asp

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