CB-ACCTG

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Lesson Plan on Capital Budgeting

Capital Budgeting - process of deciding whether or not to commit resources to projects whose costs and benefits are spread over several time periods.

Characteristics of a Capital Investment Decision:

1. Substantial amount of funds are required in capital projects.

2. Because of the length of time span by a capital investment decision, the element of uncertainty becomes more critical.

3. The effect of managerial errors will be difficult to reverse.

4. Plans must be made well into an uncertain future.

5. Success or failure of the company may depend upon a single or relatively few investment decision.

Two general types of capital investment projects:

A. Independent capital investment projects - results in an Accept or Reject decision

1. Investment in long term assets 2. New product development 3. Undertaking a large scale advertising campaign 4. Corporate acquisitions

B. Mutually exclusive investment projects - Requirement to choose an alternative and thus automatically excluding the acceptance of the other.

1. Replacement against renovation of equipment or facilities. 2. Rent or lease against ownership of facilities. 3. Manual bookkeeping system against computerized system. 4. Preventive maintenance against periodic overhaul of machinery. 5. Purchase or lease of machinery

Three important elements of Capital Budgeting

I. Net Amount of Investment

Acquisition cost Add: Additional working capital involved Total less Cash inflow arising from sale of old asset being replaced (net of taxes) Avoidable costs (net of taxes) Net Investment ============

Illustrative Problems:

1. The management of Brown Metal Fabricators plans to replace a forming machine that was acquired several years ago at a cost of P450,000. The machine has been depreciated to its salvage value of P50,000. A new machine can be purchased for P800,000. The dealer will grant a

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