MODULE 5

MANAGEMENT OF
FUNDS:

Capital Budgeting
By.,

Yathiraju K
Asst. Professor
Dept. of Commerce
Christ University
Bangalore- 29

CONCEPT OF CAPITAL
BUDGETING

Capital budgeting is the process of making

investment decision in capital expenditure.

Capital budgeting is a process of planning that is

used to ascertain the long-term investments of the
firm.

The long-term investment of a firm may be for new

machinery, new plants, replacement machinery,
new products and the research and development
projects.

MEANING AND DEFINITION

The term capital budgeting means planning for capital

assets.
In other words Planning the deployment of available
capital for the purpose of maximizing the long term
profitability of a firm.
A capital Expenditure is an expenditure, the benefits of which are
expected to be received over a period of time exceeding one year.
"According to Charles T Horn Green capital budgeting is
long term planning for making & financial proposed.
Capital outlays."

FEATURES OF INVESTMENTS
DECISIONS
1.

The exchange of current funds for future benefit.

2.

The funds are invested in long-term assets.

3.

The future benefits will occur to the firm over a series of year.

4.

Capital Expenditure once approved represent, long term

investment that cant be reversed or with drawn without
sustaining loss.

5.

Preparation of capital Budget plans involves forecasting of

several years profit in advance in order to judge the
profitability of projects.

6.

Any error in evaluation leads to heavy loss in investments.

IMPORTANCE
DECISIONS

OF

INVESTMENT

1)

They influence the firms growth in the long run

2)

They affect-risk of the firm

3)

They involve commitment of large funds.

4)

They have a long term effect on profitability

5)

They are irreversibly in nature / reversible at

substantial loss

6)

They are among the complex decisions to make

7)

They are of national importance.

PRINCIPLES OF CAPITAL
BUDGETING DECISIONS

Cost

Surplus

Large Investment

Long term effect on profitability

Long term commitment of funds

Time

Risk

Invariability

Complexity

CAPITAL BUDGETING PROCESS

KINDS OF INVESTMENT DECISION

1. Based on a profitability:

a) Those which increase Revenue

b) Those which reduces cost.

2. Based on the proposal under consideration:

a) Accept reject decision.
b) Mutually exclusive project decision.
c) Capital rationing decisions

3 On the basis of firms existence:

a) Replacement and Modernization decisions
b) Expansion decisions
c) Diversification decisions

INVESTMENT EVALUATION
CRITERIA:
3 Steps are involved in the evaluation of an
investment.
1. Estimation of cash flows.
2. Estimation of the required rate of return
3. Application of a decision rule for making the
choice

METHOD OF EVALUATION OF
INVESTMENT PROPOSALS
Traditional Methods
a) Pay back method / Pay out or
Pay off method.

b) Improvement of traditional
Approach

c) Rate of Return method /

accounting Method

Time adjusted

method/Discounted
Method

a) Net Present Value method

b) Internal Rate of Return
method

c) Profitability Index method