## The Capital Budgeting Process

Capital budgeting follows a structured six-step cycle. Each stage feeds into the next, and the review loop provides feedback for future decisions.

```

Planning → Evaluation → Selection → Implementation → Control → Review

↑____________________________________________________| (feedback loop)

```

### Step-by-Step Breakdown

Step	Name	What Happens
1	Planning	Identify potential investment opportunities; screen out poor ideas early
2	Evaluation	Estimate cash inflows, outflows, and overall viability of each proposal
3	Selection	Choose projects that maximise shareholder wealth, considering return, risk, and cost of capital
4	Implementation	Acquire funds, purchase assets, and begin project execution
5	Control	Monitor via progress reports, performance comparisons vs. plan, and post-completion audits
6	Review	Analyse the entire project to explain success or failure and improve future decisions

### Three Steps in the Evaluation Procedure (Exam Focus)

1. Estimate cash flows over the entire project life for each alternative.

2. Apply decision criteria (NPV, IRR, Payback, ARR, PI) to evaluate each alternative.

3. Determine the minimum required rate of return (WACC) to use as the discount rate.

> Memory trick: PEISICR — Planning, Evaluation, Identification (Selection), Implementation, Control, Review

Worked example

### Example 1

A pharma company identifies three expansion options (Planning). It projects 10-year cash flows for each (Evaluation) and picks the one with the highest NPV at its 12% WACC (Selection). It then borrows ₹80 crore, builds the plant, and hires staff (Implementation). A quarterly dashboard tracks actual vs. budgeted capex (Control). After Year 5, management reviews whether projected synergies materialised and incorporates lessons into the next budgeting cycle (Review).

### Example 2

A retail chain is evaluating opening stores in three cities. In the Evaluation step, it estimates incremental revenues, operating costs, and terminal values. It determines its WACC is 10%. In Selection, it uses NPV and rejects cities where NPV is negative, accepting only the two cities with positive NPV.

⚠️ Common exam mistakes

Stopping the process at 'Selection' and ignoring Control and Review—real-world capital budgeting is a continuous loop, not a one-time decision.
Using a single discount rate without computing WACC properly; the minimum required return must reflect the firm's actual cost of all capital components.
Confusing the 6-step process with the 3-step evaluation procedure—the latter sits inside Step 2 of the broader process.

Reference:

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