Planning Capital Expenditure
Steven P. Feinstein
A beer company is considering building a new brewery. An airline is deciding whether to add flights to its schedule. An engineer at a high-tech company has designed a new microchip and hopes to encourage the company to manufacture and sell it. A small college contemplates buying a new photocopy machine. A nonprofit museum is toying with the idea of installing an education center for children. Newlyweds dream of buying a house. A retailer considers building a Web site and selling on the Internet.
What do these projects have in common? All of them entail a commitment of capital and managerial effort that may or may not be justified by later performance. A common set of tools can be applied to assess these seemingly very different propositions. The financial analysis used to assess such projects is known as “capital budgeting.” How should a limited supply of capital and managerial talent be allocated among an unlimited number of possible projects and corporate initiatives?
The Objective: Maximize Wealth
Capital budgeting decisions cut to the heart of the most fundamental questions in business. What is the purpose of the firm? Is it to create wealth for investors? To serve the needs of customers? To provide jobs for employees? To better the community? These questions are fodder for endless debate. Ultimately, however, project decisions have to be made, and so we must adopt a decision rule. The perspective of financial analysis ...