This document discusses capital budgeting and capital expenditure. It defines capital budgeting as long-term planning for capital outlays whose returns will be realized in future periods. Capital expenditure involves acquiring or improving fixed assets that provide benefits over many years. The document outlines the objectives, importance, difficulties and process of capital budgeting. It also discusses factors influencing investment decisions and different types of capital budgeting decisions.

1. UNIT II
CAPITAL BUDGETING
Dr. Thulasi Krishna.K
Dept. of Management Studies
MITS, Madanapalle

2. 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.
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4. 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”.
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5. 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.
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6. 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.
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7. 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.
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8. DIFFICULTIES IN CAPITAL BUDGETING
 Future uncertainty
 Time Element
 Difficulty in Quantification of impact
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9. 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
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10. KINDS OF CAPITAL BUDGETING DECISIONS
 (a) Independent Proposals
 (b) Dependent Proposals or Contingent Proposals
 (c) Mutually Exclusive Proposals
 (d) Capital Rationing Decisions
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11. PROCESS OF CAPITAL BUDGETING
 Project Generation
 Project Evaluation
 Fixing Priority
 Project Selection
 Project Execution
 Performance Review
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Thank You
Dr. Thulasi Krishna. K
MITS