MODULE – 5MANAGEMENT OF

FUNDS:

Capital Budgeting By.,

Yathiraju K

Asst. Professor

Dept. of Commerce

Christ University

Bangalore- 29

CONCEPT OF CAPITAL BUDGETING

Capital budgeting is the process of making

investment decision in capital expenditure.

Capital budgeting is a process of planning that

is used to ascertain the long-term investments

of the firm.

The long-term investment of a firm may be for

new machinery, new plants, replacement

machinery, new products and the research and

development projects.

MEANING AND DEFINITION

The term capital budgeting means planning for capital

assets.

In other words “Planning the deployment of available

capital for the purpose of maximizing the long term

profitability of a firm.

A capital Expenditure is an expenditure, the benefits of which

are expected to be received over a period of time exceeding

one year.

"According to Charles T Horn Green capital budgeting is

long term planning for making & financial proposed.

Capital outlays."

FEATURES OF INVESTMENTS DECISIONS

1. The exchange of current funds for future benefit.

2. The funds are invested in long-term assets.

3. The future benefits will occur to the firm over a series of

year.

4. Capital Expenditure once approved represent, long term

investment that can’t be reversed or with drawn without

sustaining loss.

5. Preparation of capital Budget plans involves forecasting

of several years profit in advance in order to judge the

profitability of projects.

6. Any error in evaluation leads to heavy loss in

investments.

IMPORTANCE OF INVESTMENT DECISIONS

1) They influence the firm’s growth in the long run

2) They affect-risk of the firm

3) They involve commitment of large funds.

4) They have a long term effect on profitability

5) They are irreversibly in nature / reversible at

substantial loss

6) They are among the complex decisions to make

7) They are of national importance.

PRINCIPLES OF CAPITAL BUDGETING DECISIONS

Cost

Surplus

Large Investment

Long term effect on profitability

Long term commitment of funds

Time

Risk

Invariability

Complexity

CAPITAL BUDGETING PROCESS

KINDS OF INVESTMENT DECISION

1. Based on a profitability:

a) Those which increase Revenue

b) Those which reduces cost.

2. Based on the proposal under consideration:

a) Accept reject decision.

b) Mutually exclusive project decision.

c) Capital rationing decisions

3 On the basis of firm’s existence:

a) Replacement and Modernization decisions

b) Expansion decisions

c) Diversification decisions

INVESTMENT EVALUATION CRITERIA:

3 Steps are involved in the evaluation of an

investment.

1. Estimation of cash flows.

2. Estimation of the required rate of return

3. Application of a decision rule for making the

choice

METHOD OF EVALUATION OF INVESTMENT PROPOSALS

Traditional MethodsTime adjusted

method/DiscountedMethod

a) Pay back method / Pay out or Pay off method. a) Net Present Value method

b) Improvement of traditionalApproach

b) Internal Rate of Return method

c) Rate of Return method / accounting Method c) Profitability Index method