Capital Budgeting^99
lllll Temporal Spread The costs and benefits associated with a capital expenditure
decision are spread out over a long period of time, usually years for industrial
projects and 20-50 years for infrastructural projects∑ Such a temporal spread
creates some problems in estimating discount rates and establishing equivalences.
Project Classification
Project analysis entails time and effort. The costs incurred in this exercise must be
justified by the benefits from it. Certain projects, given their complexity and magnitude,
may warrant a detailed analysis while others may call for a relatively simple analysis.
Hence firms normally classify projects into different categories. Each category is then
analysed somewhat differently.
While the system of classification may vary from one firm to another, the following
categories are found in most classifications.
Mandatory Investment These are expenditures required to comply with statutory
requirements. examples of such investments are pollution control equipment, medical
dispensary, fire fitting equipment, clr5che in factory premises, and so on. These are
often non-revenue producing investments. In analyzing such investments the focus is
mainly on finding the most cost-effective way of fulfilling a given statutory
need.
Replacement Projects Firms routinely invest in equipments meant to replace Obsolete
and inefficient equipments, even though they may be in a serviceable condition. The
objective of such investments is to reduce costs (of labor, raw material, and power),
increase yield, and improve quality. Replacement projects can be evaluated in a fairly
straightforward manner, though at times the analysis may be quite detailed.
Expansion Projects These investments are meant to increase capacity and/or widen
the diistribution network. Such investments call for an explicit forecast of growth.
Since this can be risky and complex, expansion projects normally warrant more careful
analysis than replacement projects Decision relating to such projects are taken by the
top management.
Diversification Projects These investments are aimed at producing new products or
Services or entirely new geographical areas. Often diversiftcation projects entail
substantial risks, involve large outlays, and require considerable managerial effort and
attention. Given their strategic importance, such projects call for a very thorough
evaluation, both quantitative and qualitative. Further, they require a significant involvement
of the board of directors.
Research and Development Projects R&D projects absorbed a very Small proportion
of capital budget in most Indian companies. Things, however, are changing. Companies
are now allocating mote funds to R&D projects, more so in knowledge-intensive