Capital budgeting is the planning process used to determine whether an organization's long term investment

Investment

Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...

s such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital

Capital (economics)

In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

, or investment, expenditures.

Many formal methods are used in capital budgeting, including the techniques such as

• Accounting rate of return
  Accounting rate of return
  Accounting rate of return, also known as the Average rate of return, or ARR is a financial ratio used in capital budgeting. The ratio does not take into account the concept of time value of money. ARR calculates the return, generated from net income of the proposed capital investment. The ARR is a...
  
  
• Net present value
  Net present value
  In finance, the net present value or net present worth of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values of the individual cash flows of the same entity...
  
  
• Profitability index
  Profitability index
  Profitability index , also known as profit investment ratio and value investment ratio , is the ratio of payoff to investment of a proposed project...
  
  
• Internal rate of return
  Internal rate of return
  The internal rate of return is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return or the rate of return . In the context of savings and loans the IRR is also called the effective interest rate...
  
  
• Modified internal rate of return
  Modified Internal Rate of Return
  The modified internal rate of return is a financial measure of an investment's attractiveness. It is used in capital budgeting to rank alternative investments of equal size...
  
  
• Equivalent annuity
  Equivalent Annual Cost
  In finance the equivalent annual cost is the cost per year of owning and operating an asset over its entire lifespan.EAC is often used as a decision making tool in capital budgeting when comparing investment projects of unequal lifespans...
  
  

These methods use the incremental cash flows from each potential investment, or project.