How can I respond to Capital Budgeting may be defined as the decision-making process by which a firm evaluates the purchase of major fixed assets including - buildings, machinery, and equipment. It is a step-by-step process that businesses use to determine the merits of an investment project. It is a company's formal procedure used for evaluating possible expenditures or investments that are important in amount.

Two methods for incorporating project risk into capital budgeting decisions include the certainty equivalent method and the risk-adjusted discount rate method.

The certainty equivalent method is the first method, in which the expected cash flows are adjusted to reflect project risk - risky cash flows are scaled down, and the riskier the flows, the lower their certainty equivalent values. It is a method in which uncertain cash flows are converted into certain cash flows by multiplying them with a probability of occurrence such as cash flows. It is the risk-free cash flow that an investor considers equivalent to a higher but risky expected cash flow.

The risk-adjusted discount rate method is the second procedure or method, in which differential project risk is dealt with by changing the discount rate average-risk projects are discounted. The firm's corporate cost of capital, and above-average-risk projects are discounted at a higher cost of capital, and below-average-risk projects are discounted at a rate below the corporate cost of capital. A risk-adjusted discount rate is representing required periodical returns by investors for pulling funds to the specific property. The concept reflects the relationship between risk and return.

Discounted cash flow refers to a valuation method that estimates the value of an investment using its expected future cash flows. It attempts to determine the value of an investment today, based on projections of how much money that investment will generate in the future, and can help those considering whether to acquire a company or buy securities make their decisions. Discounted cash flow analysis can also assist business owners and managers in making capital budgeting or operating expenditures decisions and provide investors and companies with an idea of whether a proposed investment is worthwhile. Companies will typically use the weighted average cost of capital for the discount rate because it accounts for the rate of return expected by shareholders. It can be applied to a variety of capital projects as long as future cash flows can be reasonably estimated.