--- title: "Capital budgeting importance and techniques" subject: "Project Engineering" chapter: 6 key: "semester_7/project_engineering:capital-budgeting-importance-techniques" source: https://www.bctengineer.com/q/semester_7/project_engineering/capital-budgeting-importance-techniques site: BCT Engineering --- # Capital budgeting importance and techniques Project Engineering · Chapter 6: Introduction to Project Financing - Asked in: 2082 Bhadra, 2+4 marks - Video: [Capital Budgeting: NPV, IRR, Payback | MUST-KNOW for Finance Roles](https://www.youtube.com/watch?v=7gG0Evugubo) — Kenji Explains - Answer checked by Claude Opus 5.5 (high effort) on 2026-10-14 - Page: https://www.bctengineer.com/q/semester_7/project_engineering/capital-budgeting-importance-techniques - Whole chapter: https://www.bctengineer.com/md/semester_7/project_engineering/chapter-6 ## Question Why is capital budgeting important in a project? What are the techniques for evaluating capital budgeting projects? ## Short answer Capital budgeting is important because it commits large funds long-term, decisions are irreversible, and it determines future growth and risk. Techniques include non-discounting methods (payback, ARR) and discounting methods (NPV, IRR, PI), with discounting methods like NPV being more reliable. ## Answer #### Importance of capital budgeting 1. Large funds are committed for a long period. 2. Decisions are irreversible; a wrong decision may cause heavy loss. 3. It decides the future growth and profit of the firm. 4. It affects the firm's risk and its cost of capital. 5. Funds are limited, so projects have to be ranked. 6. It needs a long-term forecast of demand, cost and technology. #### Techniques for evaluating projects **Non-discounting (traditional) methods:** payback period and accounting rate of return (ARR). **Discounting methods:** net present value (NPV), internal rate of return (IRR), profitability index (PI) and benefit-cost ratio. | Method | Rule | |---|---| | Payback period | Accept if payback is less than the standard period | | Accounting rate of return (ARR) | Accept if ARR is more than the required rate | | Net present value (NPV) | Accept if NPV > 0 | | Internal rate of return (IRR) | Accept if IRR > required rate (MARR) | | Profitability index (PI) | Accept if PI > 1 | | Benefit-cost ratio | Accept if B/C > 1 | Discounting methods consider the time value of money and are more reliable; NPV is the most commonly recommended. ## Check yourself The answer's key points as multiple-choice questions, with the correct option and why. 1. Why is capital budgeting important? A. Large funds are committed for long and decisions are hard to reverse B. It involves only small, reversible decisions C. It ignores forecasts D. It concerns only daily expenses Answer: A. Large long-term commitments and irreversibility mean a wrong decision can cause heavy loss. (Key point: Importance) 2. Which pair are discounting methods? A. Payback period and ARR B. NPV and IRR C. ARR and payback D. Payback and B/C only Answer: B. NPV, IRR, PI and benefit-cost ratio discount cash flows; payback and ARR are non-discounting. (Key point: Technique classes) 3. Which acceptance rule is correct? A. Accept if PI < 1 B. Accept if NPV < 0 C. Accept if IRR > required rate (MARR) D. Accept if B/C < 1 Answer: C. Accept when NPV > 0, IRR > MARR, PI > 1 and B/C > 1. (Key point: Decision rules) 4. Why are discounting methods considered more reliable? A. They are simpler B. They use accounting profit C. They ignore later cash flows D. They consider the time value of money Answer: D. They account for the time value of money; NPV is the most commonly recommended. 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