Capital budgeting (or investment appraisal) is defined as the planning process used to determine whether a firm’s long term investments such as new machine, replacement machinery, new plants, new products, research and development projects are worth pursuing. It is a budget for major capital or investment expenditures (John Wiley and Sons, 1977). It may also be defined as the process of analyzing projects and finally venture on the accept or reject decisions in the process (Horne V, 2010).
Capital budgeting decisions can be referred to as either replacement decisions or expansion decisions or additional decisions. Expansion decisions include determining whether to acquire capital projects and add to existing assets in order to increase existing operations. Replacement capital expenditure is the capital expenditure required to replace productive capacity consumed during a reporting period. Inflation affects investment in capital assets negatively. It reduces the purchasing power and therefore companies find it difficult to add and replace existing assets in order to change existing operations.
The capital budgeting decision is an important one for any organisation in the sense that it determines the nature of the organisations operations and products over the long term. Before the organisation commits their scarce and valuable capital resources to fixed productive assets, it needs to be assured of the profitability as well as an acceptable return on the funds invested therein. Capital investments are made with the objective of realising profits and normally refer to investments in productive assets.
It is assumed that organizations generally are risk averse in the sense that in a situation where they are faced with two investment opportunities with equal returns will select the project possessing lower risk profile. Tax implications arise when investing in capital assets and they should be taken into consideration... [continues]
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