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How can capital budgeting help you maximize shareholder value?

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Capital budgeting is the process of evaluating and selecting long-term investments that align with your business goals and strategy. It involves estimating the expected cash flows, costs, and risks of various projects and choosing the ones that maximize your return on investment (ROI) and shareholder value. In this article, you will learn how capital budgeting can help you make better decisions for your business and create value for your shareholders.

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Anders Liu-Lindberg

Leading advisor to senior Finance and FP&A leaders on creating impact through business partnering | Interim | VP…
Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting
Arsalan Ahmad

Internal Audit, Governance, Risk and Compliance Trusted Advisor

1 What is shareholder value?

Shareholder value is the measure of how much wealth you create for your shareholders by generating profits, dividends, and capital gains. It reflects the market value of your company's equity, which depends on your current and future performance, growth potential, and competitive advantage. Shareholder value is influenced by many factors, such as your earnings, cash flow, risk, cost of capital, and dividend policy.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting
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Capital budgeting is a strategic financial planning process that helps companies make informed investment decisions that maximize shareholder value. It involves strategic project selection, risk management, time value of money, optimal resource allocation, and economic value added (EVA). Capital budgeting supports long-term growth, builds a competitive advantage, maximizes shareholder wealth, and influences dividend policy. It also influences market perception and valuation, allows for flexibility in financing, and ensures continuous monitoring and adjustment to changing market conditions. By utilizing capital budgeting, companies can enhance long-term profitability, maintain a competitive edge, and deliver value to their shareholders.

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Arsalan Ahmad

Internal Audit, Governance, Risk and Compliance Trusted Advisor
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In my view, the capital budgeting aids in maximizing shareholder value by systematically evaluating and selecting investment opportunities that promise the highest returns. Through rigorous analysis of projects, considering factors like risk, time value of money, and optimal capital structure, companies can make informed decisions that allocate resources efficiently. This disciplined approach ensures that investments align with shareholder expectations, contributing to sustained growth and increased overall shareholder wealth.

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2 Why is capital budgeting important for shareholder value?

Capital budgeting is important for shareholder value because it determines how you allocate your scarce resources to the most profitable and strategic projects. By investing in projects that have a positive net present value (NPV), you can increase your cash flow and earnings, which in turn boost your share price and dividends. By investing in projects that have a negative NPV, you can reduce your cash flow and earnings, which in turn lower your share price and dividends. Capital budgeting also affects your risk profile, which influences your cost of capital and required rate of return. By investing in projects that match your risk appetite and diversify your portfolio, you can lower your cost of capital and increase your shareholder value.

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3 How to use capital budgeting techniques for shareholder value?

There are various capital budgeting techniques that you can use to evaluate and compare different projects and their impact on shareholder value. The most common ones are NPV, Internal Rate of Return (IRR), and Payback Period. NPV measures the difference between the present value of cash inflows and outflows of a project and is considered the most reliable technique for capital budgeting. IRR shows the annualized rate of return of a project, which can be compared with the cost of capital or hurdle rate to decide whether to accept or reject it. However, IRR can be misleading when there are multiple IRRs or no IRRs for a project. Payback period measures how quickly a project pays back its cost and starts generating positive cash flow, but does not consider the time value of money or the profitability of a project.

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4 How to incorporate non-financial factors for shareholder value?

Capital budgeting is not only about numbers and calculations, but also about qualitative and strategic factors that can affect your shareholder value. When considering these non-financial factors, it's important to invest in projects that align with your vision, mission, and values. This will create intangible assets and goodwill that can increase your shareholder value over time. Additionally, you should invest in projects that are compatible with your existing operations, resources, and capabilities. Doing so will leverage your core competencies and competitive advantages, creating synergies and economies of scale that can boost efficiency, productivity, and profitability. Finally, it's important to invest in projects that are flexible and adaptable to changing market conditions and customer preferences. This will create value by enhancing customer satisfaction, loyalty, and retention.

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5 How to monitor and evaluate your capital budgeting decisions for shareholder value?

Capital budgeting is not a one-time event, but a continuous process that requires monitoring and evaluation. You should track and measure the actual performance and results of your projects against your expected outcomes and assumptions, and identify any deviations or discrepancies. You should also analyze the causes and consequences of these deviations or discrepancies, and take corrective actions if necessary. You should also review and update your capital budgeting criteria and techniques, and incorporate new information and feedback. By doing so, you can ensure that your capital budgeting decisions are aligned with your shareholder value objectives, and that you can learn from your successes and failures.

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Anders Liu-Lindberg

Leading advisor to senior Finance and FP&A leaders on creating impact through business partnering | Interim | VP Finance | Business Finance
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The key challenge often is that once the investment has been made and the first year has passed no one really follows up on investment performance. You can argue it’s a sunk cost regardless, however, in not doing so we fail to learn how we can improve our capital budgeting process.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Peter at B and B University College

I develop your skills so that you can obtain top International Qualifications that lead to your success!
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IMO, a key point is to remember that capital budgeting is just part of the decision model, not the final determinant Capital budgeting techniques are quantitative tools assessing past information. While this is important, maximising shareholder value focuses on the future, so there is a need to bring in judgements about expectations, risk and future scenarios before a final decision is made As the "Balanced Scorecard" concept demonstrates, value is built on several contributory factors, not just financial

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How can capital budgeting help you maximize shareholder value?

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1 What is shareholder value?

2 Why is capital budgeting important for shareholder value?

3 How to use capital budgeting techniques for shareholder value?

4 How to incorporate non-financial factors for shareholder value?

5 How to monitor and evaluate your capital budgeting decisions for shareholder value?

6 Here’s what else to consider

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