Capital budgeting is part of the planning process used by decision makers to evaluate whether or not an organization should pursue a capital (long term) investment. Examples of a long term investment are purchasing a new facility or machinery or investing in research and development or a new product. Capital budgeting occurs when a major expense is being considered.
There are several measures used when evaluating capital expenditure, such as:Internal Rate of Return Modified Internal Rate of Return
These methods use the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper - such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period.