Capital Budgeting^101
Nature of Investment Decision
Typical examples of capital budgeting decisions are:
l expansion projects;
l replacement projects;
l selection among alternatives; and
l buy or lease decisions.Good capital budgeting decisions, based on sound investment appraisal procedures,
should improve the timing of capital acquisitions as well as the quality of capital
acquisitions.
Investment in expansion/ modernisation is one of the main sources of economic growth,
since it is required not only to increase the total capital stock of equipment and buildings,
but also to employ labour in increasingly productive jobs as old plant is replaced by new.
The Administrative FrameworkSuccessful administration of capital investments by a company involves- Generation of investment proposals
- Estimation of cash flows for the proposals
- Evaluation of cash flows
- Selection of projects based upon an acceptance criterion
- Continual reevaluation of investment projects after their acceptance
Depending upon the firm involved, investment proposals can emanate from various
sources. For purposes of analysis, projects may be classified into one of five categories. - New products or expansion of existing products
- Replacement of equipment or buildings
- Research and development
- Exploration
- Others
The fifth category comprises miscellaneous items such as the expenditure of funds to
comply with certain health standards or the acquisition of a pollution-control device.
For a new product, the proposal usually originates in the marketing department. On the
other hand a proposal to replace a piece of equipment with a more sophisticated model
usually emanates from the production area of the firm, in each case, efficient
administrative procedures are needed for channeling in-
Most firms screen proposals at multiple levels of authority. For a proposal originating
in the production area, the hierarchy of authority might run from (1) section chiefs to