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Chapter 25: Capital Budgeting Decisions

Chapter Introduction​

Marie has been running Le Petit Bistro successfully for several years, and she's now considering a major investment: opening a second location and upgrading her kitchen equipment. "This isn't like buying a few extra chairs," she tells Monsieur Schneider. "These decisions involve hundreds of thousands of euros. How do I know if it's worth it?"

Monsieur Schneider explains that Marie is facing capital budgeting decisions. "Capital budgeting is about evaluating long-term investments," he says. "You need to estimate cash flows, assess risks, choose the right discount rate, and compare alternatives using techniques like NPV, IRR, and payback period. And in Luxembourg, you also have to consider financing options, tax rules, and potential government incentives."

Capital budgeting is the process of planning, evaluating, and selecting long-term investments that are consistent with a company's strategic goals. These investments—such as opening new locations, purchasing equipment, launching products, or entering new markets—require substantial capital and affect the business for years.

In Luxembourg, capital budgeting decisions are particularly important because:

  • High operating costs (rent, salaries) increase investment risk
  • SMEs often rely on bank financing, which requires solid financial projections
  • Government grants and incentives are available, but require careful planning
  • Tax rules, depreciation, and VAT impact cash flows
  • Cross-border operations and multilingual markets add complexity

This chapter teaches you how to analyze capital investments, evaluate cash flows, use discounted cash flow methods, compare projects, factor in risk, and understand Luxembourg-specific considerations.

By the end of this chapter, you'll be able to evaluate capital investments using rigorous techniques—just like Marie will learn to do for her expansion plans.

Why It Matters​

Capital budgeting matters because:

  • Strategic Impact: Long-term investments shape the company's future
  • Resource Allocation: Capital is limited; choose projects wisely
  • Risk Management: Investments involve uncertainty; rigorous analysis reduces risk
  • Stakeholder Confidence: Banks, investors, and partners expect structured evaluation
  • Compliance: Tax depreciation, grants, and subsidies require accurate projections

Luxembourg-Specific Importance:

  • High financing costs and strict lending requirements
  • Government incentives (House of Entrepreneurship, Luxinnovation) require robust plans
  • VAT, tax rules, and depreciation methods affect cash flows
  • Cross-border considerations impact cash repatriation and cost of capital

Understanding capital budgeting helps you:

  • Evaluate investment opportunities objectively
  • Compare projects using consistent metrics
  • Incorporate risk and financing considerations
  • Communicate investment cases to stakeholders
  • Make decisions aligned with strategic goals

Learning Objectives​

By the end of this chapter, you should be able to:

  1. Describe capital investment decisions and how they are applied
  2. Evaluate the payback and accounting rate of return in capital investment decisions
  3. Explain the time value of money and calculate present and future values of lump sums and annuities
  4. Use discounted cash flow models (NPV, IRR, PI) to make capital investment decisions
  5. Compare and contrast non-time-value-based methods and time-value-based methods
  6. Determine and evaluate payback periods and discounted payback
  7. Incorporate tax, depreciation, and working capital effects into cash flow estimates
  8. Understand Luxembourg SME investment decision making, including cost of capital and financing
  9. Evaluate Luxembourg government grants and investment incentives