Capital Budgeting

Meaning
Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the goal of shareholders wealth maximization. It is budget for major capital, or investment, expenditures.

Features
  

Potentially large anticipated benefits A relatively high degree of risk A relatively long time period between the initial outlay and anticipated returns

Types of capital budgeting decision

    

New machinery, new plants, new products, Replacement Expansion Diversification and Research development projects

Classification of investment
 

Mutually exclusive Independent investment

Process of capital budgeting

    

Project Generation Project Evaluation Project Selection Project Execution Follow-up

Significance of capital budgeting

   

Long term Implication Large amount of funds Most critical and difficult decision It is not Reversible

Capital Budgeting Techniques

Payback Period Expected number of years required to recover a projects cost. Payback period = E + B C Where: E = No. of years immediately preceding the year of recovery B = Balance amount of investments to be recovered C = Saving during the year of final recovery


Cont
Limitations of Payback: Ignores the time value of money. This weakness is eliminated with the discounted payback method. Ignores cash flows occurring after the payback period

Cont..
  

Average Rate of return Net present value Internal Rate of Return

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