PRE-REQUISITES OF

CAPITAL BUDGETING

PRESENTED BY:
USHBA SABIHA
 What are prerequisites ?

• A thing that is required as a prior condition for

something else to happen or exist
• Something that must exist or happen before
something else
• A basic requirement
• A necessity
 Capital

• Capital is the result of human efforts made, on

natural resources and includes all those goods
(items or commodities) which are used for
further production of more goods, e.g., machines,
tools, factory buildings, transport equipment, etc.
 Budgeting
• A budget is basically a financial plan for a defined
period, normally a year. It is an estimation of
revenue and expenses over a specified future
period of time and is utilized by governments,
businesses and individuals.
• A budget is a microeconomic concept that shows
the trade-off made when one good is exchanged
for another (Economic point-of-view)
 What is Capital Budgeting ?

• Capital budgeting is a process that helps in planning the

investment projects of an organization in long run.
• The decision of whether to accept or deny an investment
project as part of a company's growth initiatives.
• Capital budgeting is a reconciliation between the
marginal revenue and marginal cost. Marginal revenue
represents the percentage rate of return on investment
while marginal cost is the cost of capital to the business.
(Economics point-of-view)
 PREREQUISITES OF CAPITAL BUDGETING

1. Determining Capital Expenditure:

Organization needs to define its total capital expenditure for
purchasing various fixed assets. In capital budgeting, only long-term
capital expenditure is taken into account.
2. Determining the Planning Period:
The duration of any capital expenditure include a high degree of
risks. Therefore, an organization needs to clearly define the planning
period of capital expenditure.
3. Selecting Decision Rules:
Decision rules are generally selected on the basis of goals of an
organization, such as profit maximization and minimization of cost.
Therefore, before deciding criteria for decision rule, it is required to
define the objectives of investment and then selecting criteria for the
evaluation of project.
4. Collecting Data:
An organization needs to collect relevant, accurate, and
sufficient amount of data to make the capital budgeting
process successful.
i. Determining different investment opportunities
ii. Assessing the cost associated with investment
iii. Calculating the expected rate of return from investment
iv. Knowing the productive life of project
v. Becoming aware of the rate of interest in market
vi. Ensuring the availability of funds
5. Risks:
Uncertainties, such as economic recession, inflation, and change in
technology, should be taken in account by an organization during
the selection of a project. These risks may affect the profitability of
the project to a large extent

6. Irreversibility of Investment Decisions:

Organization cannot change or withdraw its investment decisions
taken once, as it may cause financial losses.
Moreover, changing the investment decisions may affect the goodwill
of the organization. Therefore, the organization should be careful,
while making project selection decisions.
Q&A
THANK YOU