Long range planning and capital budgeting are different concepts in management accounting; however, they are related in three specific areas. To begin with is time period; whereas long range plans require at least 5 years of preparing, capital budgets’ maximum length needs a year, since budgets are often made for shorter periods. Secondly, emphasis is another relating factor. Long range planning envisions long term goals, puts down strategies for their attainment and develops policies and plans for the implementation of those strategies. The expected trend in economic and political environment have to be incorporated in management and appropriate adjustments made in firms. Capital budgeting, on the other hand, aims at achieving specific short term goals. Lastly, the amount of details present in these two concepts cannot be overestimated; capital budgeting has more detailed data since it is a basis of control for achieving set goal standards. This is in comparison to long range planning, where data is for progress review; a company strategizes to capitalize performance over an extended time frame.
Importance of Cost of Capital in Capital Budgeting
Cost of capital is defined as the amount of cash paid by a firm for funds required in financing an investment. In the discounting model in capital budgeting, the payback period is discounted in that the cash flow is discounted to the beginning of the business venture reflecting time value of money and unpredictability of future cash flows; the rate at which this occurs defines the cost of capital. The cost of capital also defines the feedback required by capital suppliers in compensating them for the time value of money and the vulnerabilities accrued with the investment. It therefore suffices to conclude that more unpredictable future cash flows translate into greater costs of capital.