LIST OF CONTENTS4
INTRODUCTION TO CAPITAL BUDGETING5
CAPITAL BUDGETING PROCESS7
ORGANIZING CAPITAL BUDGETING PROCESS IN LARGE FIRMS8
CAPITAL BUDGETING DECISION RULES9
CAPITAL BUDGETING: EMERGING ISSUES AND TRENDS12
Introduction to Capital Budgeting
Indian economy as a whole has largely been insulated against the global economic slowdown, the Indian real estate sector though has been seriously affected keeping in sync with the global real estate fortunes (Economic Times, 16th June’09), nevertheless in the hotel industry there are expansions, acquisitions and exceptionally diverse structures are coming up in different markets to attain incredible growth in the business. The union budget 2009-2010 had a lot in store for the hotel industry in specific by the abolition of the fringe benefit tax in attracting and retaining the employees. Other benefits being the development of rail, road and airports through the India Infrastructure Finance Company Ltd. and the increased budget for the commonwealth 2010 (Krupa Vohra, Travel Professional). The Indian hospitality industry of which hotels form a part is valued at $23 billion and comprise of 75% total market size. The hotel market is expected to double by the year 2018 and about $12 billion is likely to be invested in the next two years and by 2011 there will be round 40 new international hotel brands operating in India as expressed by the Technopak Advisors, New Delhi through the Business Standard. When a business makes a capital investment it incurs cash expenditure in the expectation of future benefits, usually these benefits extend beyond 1 year in the future. An investment proposal should be judged in relation to whether or not it provides a return equal to or greater than required by the investors. The process of identifying, analyzing and selecting investment projects whose returns (cash flows) are expected beyond 1 year is called Capital Budgeting. (Horne J. C., Wachowicz Jr J., Bhaduri S., 2008) Capital investments include investment in assets such as equipments, buildings, lands as well as the introduction of a new product, any up gradation or new program for research and development so in a long term the firm’s future success and profitability depends on long term decision currently made. Capital budgeting is a very essential aspect of a firm’s financial management. If a firm makes a mistake in its capital budgeting process, it has to live with it for a long period of time and face losses. Overestimation and underestimation of the proposed investment may lead to a disaster for the company as the capital investment decisions are of non reversible in nature. Overinvestment will increase the depreciation and other costs while the company would succumb to competition due to under investment in capacity and high cost of regaining lost customer (Iyengar A., 2008) The selection of an investment project may affect the business-risk complexion of the firm which in turn may affect the rate of return required by investors, the capital budgeting process involves: Generating investment project proposals consistent with the firm’s strategic objectives. Estimating after-tax incremental operating tax cash flows for investment projects. Evaluating project incremental cash flows.
Selecting projects based on a value-maximizing acceptance criterion. Reevaluating implemented investment projects continually and performing post audits for completed projects. The typical case with the hotel industry is that the largest investment made is in fixed assets where in a significant proportion of fixed assets is not subject to obsolescence (Collier & Gregory, 1995; Parkinson, 1995). Fixed asset investment can be seen as the output of the capital budgeting process that involves the long-term allocation of organizational funds across departments and projects in...