Unit 2-fm-capital budgeting tk-ppt

UNIT IICAPITAL BUDGETING

Dr. Thulasi Krishna.K

Dept. of Management Studies

MITS, Madanapalle

CAPITAL EXPENDITURE

A capital expenditure is an expenditure incurred for acquiring or improving

the fixed assets, the benefits of which are expected to be received over a

number of years in future.

Examples of capital expenditure:

1) Cost of acquisition of permanent assets such as land & buildings, plant &

machinery, goodwill etc.

2) Cost of addition, expansion, improvement or alteration in the fixed assets.

3) Cost of replacement of permanent assets.

4) Research and development project cost etc.

Capital expenditure involves non-flexible long term commitment of funds.

DEFINITION OF CAPITAL BUDGETING

According to Charles T. Horngreen , “Capital budgeting is long-term

planning for making and financing proposed capital outlay”.

Milton H. Spencer defines ‘capital budgeting’ as “Capital budgeting

involves the planning of expenditure for assets, the returns from

which will be realized in future time periods”.

FEATURES OF CAPITAL BUDGETING

Investment proposal for which the Capital Budgeting technique is to be applied

should be of a long-term nature.

Proposed investment is to be made during the current period, but return from the

investment will be obtained over a number of years in the future period.

Expenditure for the proposed investment and return from such investment should be

measured in terms of cash flow, that is, cash outflow and cash inflow respectively.

Investment decision may be taken for a single project proposal, or for two or more

mutually exclusive project proposals.

Acceptance or rejection of an investment proposal should be based on the

maximization of value of the firm.

OBJECTIVES OF CAPITAL BUDGETING

To ensure the selection of the possible profitable capital projects;

To ensure the effective control of capital expenditure by forecasting the

long-term financial requirements;

To make estimation of capital expenditure during the budget period and to

see that the benefits and costs may be measured in terms of cash flow;

To determine the required quantum takes place as per authorization and

sanctions;

To facilitate co-ordination of inter-departmental project funds among the

competing capital projects and

To ensure maximization of profit by allocating the available investible funds.

IMPORTANCE OF CAPITAL BUDGETING

Capital budgeting decisions involve long-term implication for the firm, and

influence its risk complexion.

Capital budgeting involves commitment of large amount of funds.

Capital decisions are required to assessment of future events which are

uncertain.

Wrong sale forecast may lead to over or under investment of resources.

In most cases, capital budgeting decisions are irreversible. This is because

it is very difficult to find a market for the capital goods. The only alternative

available is to scrap the asset, and incur heavy loss.

Capital budgeting ensures the selection of right source of finance at the

right time.

DIFFICULTIES IN CAPITAL BUDGETING

Future uncertainty

Time Element

Difficulty in Quantification of impact

FACTORS INFLUENCING INVESTMENT DECISIONS

Technological change

Competitors' strategy (Ex: A low-cost leader strategy, A brand

differentiation strategy)

Demand forecast

Type of management

Tax policies of the government

Cash flows

Return expected from the investment

KINDS OF CAPITAL BUDGETING DECISIONS

(a) Independent Proposals

(b) Dependent Proposals or Contingent Proposals

(c) Mutually Exclusive Proposals

(d) Capital Rationing Decisions

PROCESS OF CAPITAL BUDGETING

Project Generation

Project Evaluation

Fixing Priority

Project Selection

Project Execution

Performance Review

12

Thank You

Dr. Thulasi Krishna. KMITS

Unit 2-fm-capital budgeting tk-ppt

Education

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