Capital budgeting is selecting which projects will be done when there are more good projects than the

capital budget can fund. Projects only reach the stage of final consideration if they have a positive PW and

an acceptable IRR, so the problem cannot be solved by eliminating bad projects. $($Those are already out of

consideration.$)$ These projects often have different lives, different scales $($some are much more expensive

than others$),$ and different levels of risk. Thus, they cannot be compared by selecting the largest PWs$.$

There are two analytical approaches for numerical results. One approach uses mathematical

programming to select the best set of projects to maximize PW$.$ If the number of projects being

considered is small and even fewer will be funded $($for example, $2$ out of $6$ for $15$ different pairs$),$ then

this can be done by hand rather than through mathematical programming.

The second approach ranks projects from highest to lowest by each project's IRR. Then, projects

starting with the highest IRR are tentatively selected for funding until the budget runs out. The IRR

of the last project selected or the first project not selected is the opportunity cost of capital for that set of

projects and that level of funding. This is one approach for defining what interest rate should be used for

capital budgeting.

The analytical approach for defining which projects should be selected is followed by a decision$-$

making stage, which often includes judgments by decision makers on strategic direction $($a promising

project that is not a good strategic fit may simply be a distraction that should be ignored$),$ the relative

amount of optimism in the numbers for different projects, the risks of different projects, the resources

available, and information that could not be numerically quantified in monetary terms for inclusion in the analysis. Particular managers will also often promote projects that will be undertaken by their group.

This stage integrates more easily with ranking on IRR, which is why that approach is somewhat more

common in practice. Virtually all capital budgeting processes consider PW$,$ IRR, and other information

such as that described in Section $4\mathrm{.}3\mathrm{.}10.$ Maximizing the benefits from the deployment of limited

resources is what provides competitive advantage and increased chances of success. Wise deployment of

capital is what creates strong firms and economies.