There are many investments that a company can make. It is a financial managers job to help the management team evaluate the investments, rank them and suggest choices. This process is called capital budgeting.
Some investments, however, defy financial analysis; an example of this may be seen in charitable donations, which provide intangible benefits that financial mangers alone cannot evaluate.
It may be argued that investment decisions fall into one of three basic decision categories:
Accept or reject a single investment proposal
Choose one competing investment over another
Capital rationing with this particular category, the limited investment pool is active deciding which projects among many should be chosen.
Whilst each corporation uses its own criteria to ration its limited resources, the major tools are:
Payback period
Net present value
Payback period method many companies believe that the best way to judge investments is to calculate the amount of time it takes to recover their investments.
Analysts can easily calculate paybacks and make simple acceptance or reduction decisions based on a necessary...
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