CAPITAL BUDGETING DECISIONS
(Source:- Book on Financial Management by Prof. I.M. Pandey)Capital budgeting means investment decisions involving fixed assets i.e., the long term
assets used in production. The budget is a financial plan pertaining to inflows and
outflows for a prescribed period. In capital budget focus will be on what is to be
included.
Investments in fixed assets are meant for long term use. Therefore higher the
investments in fixed assts, the lower are the flexibility. The forecasting of returns must
correspond to the life of the fixed assets.
The threat of changing technology affecting the price and quality will heavily influence
the investment in long term fixed assets. Once invested in long term fixed assets, going
back may be impossible and such going back will be a costly affair.
Investment in Capital Assets (i.e., in large term assets) must be done in appropriate time.
There must be match between the demand and the marketing of the goods produced. If
these two are mismatched one cannot justify the investment in capital assets. Perhaps
even it may be disastrous.
The firm must anticipate in advance when it needs to go in for new machinery or to
change the existing one. Otherwise a firm may not be in a position to take advantage of
the demands prevalent in the market.
Because of the various complications involved in capital budgeting, a firm has to plan the
capital expenditure properly.
The proposal for capital budgeting may start from the demand for a particular new
product in the market. This will lead to obtaining customers' opinion, demand analysis,
limitations, capacity building, cost and price analysis and profit analysis, finally leading
capital budgeting project.
The changing needs of the customers in terms of change in the product in terms of
quality, quantity or for a new product or his opinion of uncomfortableness with the
existing product, his opinion on price etc., will always influence the growth or expansion
of a firm. A firm if it wants to survive must be able to be responsive to the changing
needs of the customers. This will form the base for capital budgeting proposals. A firm
must-have strategic business plan to be flexible enough to meet the changing marketing
challenges. The internal staff of a firm has to be encouraged to come up with the new
capital investment proposals. Every proposal has to be screened, before selecting or
rejecting. The analyzing of every such proposals itself, involves cost. The proposals
may be categorized as follows:
- Replacement of worn-out or damaged equipment to maintain the existing level of
business