Capital Budgeting

Investments in new product lines involve investment decisions, on the basis of which a firm can reap benefits arising out of the emerging business opportunities. Capital budgeting is an important part in the investment decisions. Capital budgeting decisions involve evaluation of specific investment proposals. Here the word capital refers to the operating assets used in production of goods or rendering of services. Budgeting involves formulation a plan of the expected cash flows during the future period. Capital budgeting decisions involve investment of current funds in anticipation of cash flows occurring over a series of years in future. All these decisions are strategic because they change the profile of the organisations. Capital expenditure decision involves forecasting of future operating cash flows. Forecasting of future cash flows demands certain assumptions about the behaviour of costs and revenues in future.

Phases of Capital Expenditure Decisions Identification of investment opportunities Evaluation of each investment proposal Examination of the investments required for each investment proposal Preparation of the statements of costs and benefits of investment proposals Estimation and comparison of the net present values of the investment proposals Examination of the government policies and regulatory guidelines Budgeting for capital expenditure for approval by the management Implementation Post-completion audit

Identification of Investment Opportunities. A proposal may to Add new products to the companys product line Expand capacity to meet the emerging market at demand for companys products Add new technology based process of manufacture that will reduce the cost of production.

Before deciding the investment decisions a few things are required to be considered. Analysing the demand and supply conditions Market surveys on customers perception Evaluation of R & D Economic growth of the country Public awareness environmental protection

Capital budgeting decisions could be grouped into two categories Decisions on cost reduction programmes Decisions on revenue generation through expansion

Capital budgeting process A proposal should be commercially viable. The following aspects are examined to ascertain the commercial viability of any investment proposal Market for the product Availability of raw materials Sources of raw materials Locational advantages Infrastrural facilities Consumption trend Competition and players in the market Availability of substitutes Purchasing power of consumers Regulations

Technical appraisal Selection of process know-how Decision on determination of plant capacity Selection of plant, equipment and scale of operation Plant design and layout General layout and material flow Construction schedule Economic Appraisal Economic appraisal examines the project from the social point of view, referring the impacts on Income distribution in the society Fulfillment of certain social objectives Savings and investments in the society Environment

Financial Appraisal Financial appraisal technique examines Cost of the project Investment outlay Means of financing and the cost of capital Expected profitability Expected incremental cash flows from the project Break-even point Risk dimensions of the project Tax concessions if any