Easy Question--Captial Budgeting

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Business Finance

Question Description

What is capital budgeting and what is the difference between independent and mutually exclusive projects?

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Explanation & Answer

Capital budgeting in layman's terms is the budgeting of money. Basically, it is the act of analyzing the fiscal cost and benefit of undertaking a specific investing or operational or manufacturing or other type of venture. Cash flow statements are analyzed amongst other analytic methodologies and the amount of cash/capital that is stood to be used and the amount of cash/capital that is stood to be made at the end of the venture is determined. By analyzing if cash flow will increase or decrease and if the venture is profitable, a company or other business entity can determine how favorable or unfavorable it is to undertake the given venture they are considering. 

The classification of a project as independent or mutually exclusive is crucial to determining if it should be under taken or not. An independent project is a project that can be analyzed on the basis of its own merits, as it being undertaken or not undertaken will not have an impact on whether other projects are accepted or declined. If the capital budgeting appears profitable, then there are usually little reservations about carrying out an independent project. And if the capital budgeting is not profitable, then there are no reasons to continue the project as it's completion does not affect other projects. Basically, independent projects are simple in that they don't interfere with other projects or require an aggregate or holistic analysis, and can be examined individually on their merit alone.

Mutually exclusive projects on the other hand describes a situation in which two projects interfere or impact each other in a negative way such that only one should be chosen, ideally. A common example would be two projects that do the same exact thing and would therefore be redundant if carried out in unison.

Overall, more than one mutually exclusive project may satisfy the capital budgeting, BUT only one can be chosen. This differs from independent projects as every independent project that satisfies the capital budgeting, may be chosen. 



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Cenfunag F (1995)

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