Choose the option that represents the sequence of steps involved in capital budgeting analysis?

A. Identification of investment/project
B. Application of capital budgeting technique
C. Forecasting the cash flows
D. Accept/reject decision
E. Calculation of cash flow after tax

Choose the correct answer from the options given below:

Correct option is D

Capital budgeting is a systematic process used to evaluate long-term investment opportunities. The correct sequence of steps in capital budgeting ensures proper decision-making and financial planning.

1. Identification of Investment/Project (A):

   • The first step is to identify potential investment opportunities or projects that align with the company’s objectives. These may include expansion, modernization, or cost-saving projects.

2. Forecasting the Cash Flows (C):

   • Once a project is identified, businesses estimate future cash inflows and outflows related to the investment. This helps in understanding the project's financial viability.

3. Calculation of Cash Flow after Tax (E):

   • Since investment decisions are based on net returns, tax implications must be considered. Cash flows after tax provide a clearer picture of actual earnings from the project.

4. Application of Capital Budgeting Technique (B):

   • Various techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index are applied to analyze the project’s feasibility.

5. Accept/Reject Decision (D):

   • Finally, based on the analysis and evaluation, the decision-makers approve or reject the project depending on expected profitability and financial viability.

Thus, the correct sequence is: A → C → E → B → D.

Information Booster:

Capital budgeting is a critical financial process that helps companies evaluate large investment projects before committing funds. It ensures that capital is allocated efficiently to maximize returns and minimize risks.

Key techniques used in capital budgeting include:

• Net Present Value (NPV): Measures the present value of future cash flows and determines profitability.

• Internal Rate of Return (IRR): Finds the discount rate at which NPV becomes zero.

• Payback Period: Estimates the time required to recover the initial investment.

• Profitability Index (PI): Determines the value created per unit of investment.

Effective capital budgeting improves a company's financial health, supports long-term planning, and enhances shareholder value.