Topics: Net present value, Cost-benefit analysis, Internal rate of return Pages: 20 (6002 words) Published: December 7, 2012
m.Module 3

Meaning of Capital Budgeting :-
Capital Budgeting is the process of making Decisions regarding long term investments in Fixed Assets which are not meant for sale. It is long range planning to employ the available capital for the purpose of maximizing the long term profitability of the concern.

Definition of Capital Budgeting:-
Prof I.M.PANDEY Defines Capital Budgeting as the firms decision to invest its current funds most efficiently in long term activities in anticipation of an expected flow of future benefits over a series of years.

Charles T Horngren Defines Capital Budgeting is long term planning for making and financing proposed capital outlays.

Features of Capital Budgeting:-
1. The exchange of current funds for future benefits
2. Funds are invested in long term assets
3. High Risk

Importance of Capital Budgeting:-

1. Long term Effects: - Capital Budgeting decisions determine the future destiny of the firm. An appropriate decision can yield amazing returns; where as a wrong decision can endanger the survival of the firm.

2. Associated with Risk; - Long term investment of funds is exposed to different types of risks. The longer is the period of the project, the greater may be the risk and uncertainty.

3. Large size of funds: - Capital Budgeting Decisions require large amount of funds for acquisition of fixed assets.

4. Irreversible Decisions:-Capital Budgeting Decision is irreversible and the amount invested cannot be realized back.

5. Wealth Maximization of Shareholders: - The basic objective of financial management is to maximize the wealth of the shareholders therefore the objective of capital budgeting is to select those long term investment projects which are expected to make maximum contribution to the wealth of shareholders in the long run.

Objectives of Capital Budgeting: -

1. Evaluation of Proposed Capital Expenditures: - Evaluation of capital expenditure to be incurred on various assets by the firm during the budget period can be made. This enables to measure the viability of each expenditure.

2. Determination of Priority: - In Capital budgeting, the priority among various capital projects is determined so that management is able to select most profitable project.

3. Co-ordination between Capital Expenditures :- The co-ordination among different capital expenditures help in maintaining equilibrium among capital expenditures to be incurred by various departments. 4. Control over Capital Expenditure:-An Effective control of Capital Budgeting helps in comparing actual expenditure with pre-determined expenditure.

5. Financing for Capital Expenditures:- Capital Budgeting enables to know the expenditures to be incurred in future on various assets, so that the management can arrange for it in time.

6. Analysis of past Decisions: - Expenditures incurred in the past are analyzed in Capital Budgeting. this enables the management to know the extent to which these decisions were correct.

Capital Budgeting refers to the total process of generating, evaluating, selecting and following up of capital expenditure alternative. Capital Budgeting Process Involves
1. Project Generation:- the capital Budgeting process begins with the generation or identification of investment proposal. The proposal or the idea about the potential investment opportunities may originate within the firm or outside the firm; the projects may be either revenue generating projects or cost reducing projects. 2. Project Evaluation: - The next step in the capital Budgeting process is to evaluate the profitability of various projects. This involves two steps a) estimation of costs and benefits in terms of cash flows and b) Selecting an appropriate criterion to judge the desirability of the projects. The criterion selected may be consistent with the firm’s objectives of maximizing its market value. 3. Project...
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