Investment refers to all kinds of spendings made to acquire, sustain, and increase production factors.

Capital expenditure refers to outlay of funds by the firm that is expected to produce benefits over a period of time longer than one year.

Capital budgeting refers to the process of evaluating and selecting long-term investments which are consistent with the firm’s main objective of maximizing shareholders’ wealth.

1. Identifying potential investments
2. Analyzing the set of investment opportunities, isolating those that will create shareholder value, and prioritizing them if necessary
3. Implementing and monitoring the investment projects selected

1. Replacement of the existing plant and equipment
2. Modernization of the existing plant and equipment
3. Expansion of the existing and new products

1. Mutually exclusive projects: the type of projects in which selecting one project prevents other projects from being undertaken.
2. Independent projects: the type of projects in which projects are not in direct competition with one another.
3. Contingent projects: the type of projects in which approval or rejection of a project is contingent on approval or rejection of another project.

Strategy refers to formulation and implementation of a company’s key decisions.

Corporate strategy refers to strategies for company’s whole portfolio of resources, and strategies for business unit’s products, as well.

In perfectly competitive markets it is assumed that it is not possible to find investment projects which provide positive net present value.

Competitive advantage refers to a firm’s attribute that may allow the firm to generate economic profits.

Economic profit refers to the risk-adjusted present value of revenue minus all costs, including the opportunity cost of capital.

Positive economic profits (or positive net present value projects) can stem from two sources: i) market imperfections, ii) creating competitive advantage.

Incremental cash flow refers to a change in a firm’s net cash flow attributable to an investment project.

Sunk cost refers to a cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected.

Opportunity cost refers to the return on the best alternative use of an asset; the highest return that will not be earned if funds are invested in a particular project.

Externalities refer to the way in which accepting a project affects the cash flows in other areas of the firm.

Financing costs are irrelevant cash flows to capital investment project evaluation which should not be included in the analysis. Although interest and loan payments require cash outflow, one should exclude them while making estimations of cash flows. The reason is cost of financing or minimum rate of required return is included in the capital budgeting analysis in the discount rate. Financing costs are incorporated in the process with the discount rate. Therefore, it would be double-considering if we included financing costs as cash outflows.

Depreciation is considered as a relevant cash flow to capital investment project evaluation which should be included in the analysis. In fact, depreciation is a non-cash expense item, but it affects the taxable income of a company. It means that although one does not need any cash to pay depreciation expense each year, it changes the amount of taxes paid which is a cash expense. Remember the income statement and note that depreciation expense is subtracted from revenue, and EBITDA (earnings before interest, tax, depreciation and amortization) is found. It means that it is deducted before the tax expense is calculated. By this way, depreciation creates a tax-shield. Likewise, in capital investment project’s income statement, depreciation is deducted before the tax expense is calculated. To calculate the cash flow of a project, we should add depreciation amount back to the project’s net income.

Payback period technique tells the length of time it takes to get the initial cash outflow back.

Discounted payback period technique
tells the length of time it takes cumulative
present values of cash inflows will be equal
to the initial cash outflow.