 While practicing capital budgeting techniques, there are certain principles or assumptions that a financial analyst needs to consider. These principles are equally applicable to all sorts of capital projects, whether it is an expansion plan or it is a replacement project. So far as the assumptions of capital budgeting are concerned, the first assumption is that in capital budgeting cash flows are used. In fact, accounting incomes and other accounting data are transformed into cash figures. So cash flows in terms of cash outflows and cash inflows are used as a base for capital budgeting. Then timings of cash flows are much critical. The analyst has to be considered the timings of the cash inflows and cash outflows at initial of the project. What types of cash flows are there and at what timing they are to be occurred. Then throughout the life of the project, what type of cash inflows and cash outflows are to be occurred. And at the terminal stage of the project, what types of cash flows are there and at what timings they are to incur. Then cash flows are based on opportunity cost. This means there are two types of cash flows. The cash flows which are related if an investment is undertaken and the cash flows which are not accrued if an investment is not undertaken. So the difference between these two is the incremental cash flows. These are the cash flows that has to be considered. Then cash flows are analyzed on after tax basis. The cash flows after tax are the base for the capital budgeting. Financing costs are ignored. This means that to determine present value of cash inflows and cash outflows, we use the required rate of return. And these cash flows are of three types. Cash flows from operations and cash flows from initial investment. Cash flows on initial investment, cash flows from the terminal project. The operating cash flows are the cash flows that occurred before any sort of interest expense. If we deduct interest expense from operating income while determining the operating cash flows, then we also taking the financing cost as the required rate of return along with the cost of equity. In this way we are double counting the financing cost. So better is to determine cash flows before the interest expense. There are certain terms that are necessary to be understood while practicing capital budgeting technique. First is the accounting net income. This is the income that is determined while using the accounting principles. This income is also termed as accrual income. Economic income. In economic income, accounting principles are not considered rather economic income is derived taking into the marketing factors rather market prices. Cash flows. These are the cash inflows and cash outflows that occur across the life of the project from the initial stage to the terminal stage of the project. Cash flows are determined through the transformation of accounting income with the adjustment of certain non-cash items like depreciation and other provisions. Cost of capital. This is the opportunity cost that at which the cash flows of the project are discounted in order to determine the present value of the project. Sunk cost. These are the cost that has been occurred in the past but these costs are now irrecoverable through the normal business operations. Hence, these sunk costs are irrelevant cost for the capital budgeting process. Opportunity cost. Opportunity cost means the cost that is incurred through sacrifice the second best alternative. This opportunity cost may be occurred while replacing an old machine with a newer machine while investing an amount anywhere in the stock market while laying a piece of land idle from the company. Incremental cash flows. These are the differential cash flows. In fact, these cash flows are occurred as a result of some decision taken by the management. This means the occurrence of cash flow subject to the decision of the management on a project may yield some incremental cash flows. These are the effects that occur due to the effect of the investment undertaken as a result of capital budgeting on the part of firm. Conventional versus non-conventional cash flows. By conventional cash flows, we mean if a project starts with some cash outflows but followed by a series of cash inflows, then these cash flows are known as conventional cash flows. But a project that is started with cash outflows, but during the life of the project, there are also certain cash outflows along with the cash inflows, then these cash flows are termed as unconventional cash flows. What are the project interactions? First is the independent versus mutually exclusive projects. Independent projects are those projects whose cash flows are independent of each other. But by mutually exclusive projects, this means that we cannot take alongside the both projects. We have to choose a single project among the group of the projects. They are mutually exclusive among the group projects. Project sequencing in some projects at the start of a project, once the project is undertaken during the way, there comes a time when we have to set up another project. So a project after a project is termed as a project sequencing. Unlimited funds versus capital rationing. Unlimited funds is a situation where firm has so much funds that the firm can accept any capital with a positive NPV are having a required rate of return. But capital rationing is a situation where the firm has not sufficient funds in order to invest in all of the desired projects. Therefore, the firm has to ration its funds with reference to the profitability and acceptance of the required rate of return of the project. In this way, the company distributes is limited funds among those capital projects that can yield positive NPV for the shareholder value maximization.