Long term effect on profitability (Growth)
A firm’s decision to invest in long term assets has a decisive influence onthe rate & the direction of its growth.
Most investment decisions are irreversible. It is difficult to find a market for capital item once they have been acquired.
Long term commitment of funds (Risk)
A long term commitment of fund may also change the risk complexity of thefirm. If the adoption of an investment increases average gain but causesfrequent fluctuation in its earnings, the firm would become more risky.
Large investment (Funding)
Investment decisions generally involve large amount of funds, which makeit imperative for the firm to plan its investment programs very carefully andmake an advance arrangement for procuring finances internally or externally.
TYPES OF CAPITAL BUDGETING
There are many ways to classify investments. One classification is asfollows:
The Expansion of Existing Business
A company may add capacity to its existing product lines to expand existingoperations. For example Gujrat State Fertilizer Company may increase its plant capacity to manufacture more urea it is an example of relateddiversification.