Capital Budgeting

Introduction

Decision making procedures involved in making capital expenditure is known as capital budgeting. Expenditure made with a view to reap extra benefits over a long period (more than a year) are regarded as capital expenditures. Expenditures incurred for acquisition, expansion and modification of fixed assets; research and the development expenditure for product development and cost reduction; expenditures incurred in compliance to statutory regulation as to labor, social welfare and environmental issues are major forms of capital expenditures. Thus capital budgeting is the long-run decisions for making and financing investment of capital nature.

Long run investment decision cannot be made on ad-hoc basis as they:

Ø       Involve substantial amount or require large investment;

Ø       How long term implication on account of their effect on the nature, growth and size of the firm;

Ø       Are difficult to reverse or change without incurring huge loss once they are taken;

Ø       Are difficult to make as they relate with uncertain future, etc.

A systematic procedure must guide these decisions.

Capital budgeting procedure

The following represent the procedure involved in capital budgeting:

(1)                          General of investment proposals.

(2)                          Estimation of cash flows.

(3)                          Evaluation of investment proposals based on different methods of screening the proposals.

(4)                          Selection of the proposals base upon the selection criteria.

(5)                          Continual revaluation of the proposals after their acceptance.