CAPITAL BUDGETING

ANALYSIS OF RELEVANT
CASH FLOWS
INTRODUCTION
A company plans for two basic aspects of the business: short-term operations
and long-term operations. A finance manager would want to efficiently use
short-term operating assets in terms of liquidity and turnover. The operating
manager, for his part, uses the cash budget as his main financial analysis tool.
Chapter 10 presented the concept of cash budget and Chapter I3 discussed
techniques of forecasting. A finance manager would also want efficiency in
long-term operations as indicated by profitability and the recovery of investment.
The manager`s main financial analysis tools are break-even analysis and
capital budgeting. Chapter 14 examined break-even analysis. This chapter
presents capital budgeting concepts and cash flow analysis principles and
techniques.
The chapter has four sections:
Section 15.1 The Capital Budgeting Process discusses the steps involved
in capital budgeting. It provides an overview of the strategic planning and
project management issues. The task of analyzing capital budgeting proposals S
is a part of planning and monitoring capital expenditures.
Section 15.2 Identifying the Relevant Cash Flows defines
flows aw appropriate for analyzing capital budgeting proposals.
provings a classification of the different cash flows in cap
proposals.





Section 15.3 Applying Cash Flow Analysis presents approlwhelfqf, .W il
cash How analysis on three classes of capital budgeting problems, Tha V
types are cost savings projects, vertical integration projects and congt Q '
expansion projects.
Section 15.4 Computer Spreadsheet and Cash Flows show; hw
adopt the formulas in the preceding section to computer spremshnm
facilitate computation and analysis. -
The Capital Budgetln
company. These expenditures significantly affect the future profitability ol
company and the price of its stock. A company grows by undertaking new
projects and expanding its business. It must find new ways of doing bustneif
at a reduced cost. With more resources, a company improves its capabilityto
be involved in new businesses.
Scope of Capital Budgeting _.a
Here are some familiar examples of problems that require the applicatt
ofcapital budgeting analysis. '
a) Whether to replace a machinery or not
b) Whether to undertake a plant expansion
c) Whether to open a new branch 3
d) Whether to refinance an existing long-terrn loan
e) Whether to lease or buy a property
f) Whether to buy or make a product
K)
h) Whether to acquire a new business or not
i) What price to bid for a new business to be acquired Q
j) Whether to install a new equipment that will reduce opera
costs
Capital expenditures are cash outlays that generate long-term benefits tori
Whether to manufacture a new product or not 1