Capital Budgeting

The capita! allocation problem consists of allocating a (usually fixed) budget among a number of investments or projects We distinguish between capital budgeting treated here and portfolio problems treated in the next section, although the two are related. Capital budgeting typically refers to allocation among projects or investments for which there are not well-established markets and where the projects are lumpy in that they each require discrete lumps of cash (as opposed to securities, where virtually any number of shares can be purchased).

Capital budgeting problems often arise in a firm where several proposed projects compete for funding The projects may differ considerably in their scale, their cash requirements, and their benefits. The critical point, however, is that even if all proposed projects offer attractive benefits, they cannot all be funded because of a budget limitation Our earlier study of investment choice, in Chapter 2, focused on situations where the budget was not fixed, and the choice options were mutually exclusive, such as the choice between a red and a green car. In capital budgeting the alternatives may or may not be mutually exclusive, and budget is a definite limitation

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