# What Financial Metrics to Consider When Making Capital Budgeting Decisions

Capital budgeting decisions are some of the most important decisions that businesses make. These decisions involve investing in long-term projects that will affect the company’s profitability and growth. As such, it is important to consider the financial metrics associated with these projects before committing to them.

The most important financial metric to consider when making capital budgeting decisions is the expected return on investment (ROI). This metric measures the projected return on the investment based on the projected cash flows. The higher the ROI, the more attractive the investment is. It is important to consider the risks associated with the project when calculating the ROI.

Another financial metric to consider is the payback period. This is the amount of time it takes for the investment to generate enough cash flow to cover its initial cost. A shorter payback period is generally preferred, as it indicates that the investment will generate returns sooner.

Net present value (NPV) is another metric that should be considered when making capital budgeting decisions. This metric takes into account the time value of money by discounting the projected cash flows to their present values. NPV is calculated by subtracting the initial cost from the discounted cash flows. A positive NPV indicates that the investment is expected to generate a return.

Internal rate of return (IRR) is another important financial metric to consider when making capital budgeting decisions. This metric measures the rate of return that is earned on the investment. It is calculated by finding the discount rate that makes the NPV of the project equal to zero. A higher IRR is preferred, as it indicates a higher return on investment.

Finally, it is important to consider the cost of capital when making capital budgeting decisions. This is the cost of borrowing money or the cost of equity. It is important to consider the cost of capital when calculating the ROI and other financial metrics.

In conclusion, there are several financial metrics that should be considered when making capital budgeting decisions. These include the expected return on investment, payback period, net present value, internal rate of return, and cost of capital. By considering these metrics, businesses can make informed decisions about their investments and ensure that they are making the best use of their resources.