Budgeting is the process of long
range planning involving investment of
funds in long term activities whose benefits
are expected over a series of years.
It is a continuous process and is carried out
by different functional areas of
management such as production,
Examples of capital budgeting decisions:
related to setting up of factories
Decisions related to installing a machinery
Decisions relating to creating additional
capacity to manufacture a part which at
present is purchased from outside.
WHY ARE THESE DECISIONS
long term growth: These decisions
affect the rate and direction of long term growth
of the enterprise.
Involves large amount of funds: These
decisions are planned after careful evaluation of
Involves high risk and uncertainty:
These decisions involve risk and uncertainty
associated with the future cash flow of the
project. The rate of earning may fluctuate and
the firm may become more risky.
decision by nature: These
decisions once taken are not easily reversible
without incurring heavy losses. The firm will
incur heavy losses if long term assets are
scrapped on reversing the investment
TYPES OF CAPITAL BUDGETING
COST REDUCTION DECISIONS
decisions- Replacing a
fixed asset due to the expiry of the
economic life of asset is called
decision- Replacing a
fixed asset due to technological
obsolescence is known as modernisation
TYPES OF CAPITAL
Decisions: Increasing the
production capacity to avoid shortage or
delay in the delivery of products or services.
E.g. Increasing oil refining capacity from 1000
to 2000 tonnes.
a new product line to capture the new
investment opportunities and increase
revenues. E.g. ITC Ltd.
TYPES OF CAPITAL
Exclusive Decisions: The
decisions are said to be mutually exclusive if
two or more alternative proposals are such
that the acceptance of one proposal will lead
to the rejection of another.
Accept reject decisions: These decisions
do not compete with each other and one or
more proposals which meet the decision
criterion of the firm can be accepted.