CAPITAL BUDGETING THE CONCEPT
Capital budgeting is the technique of making long-term planning decisions for investment and their finance. Decisions on capital expenditure are difficult as future is uncertain. It includes current cashoutlay or a series of cash outlays in return for an anticipated flow of future benefits. Capital budgeting is employed to evaluate long-term expenditure decisions which involve current outlaysand the benefits that occur in the future years.
Objectives of capital budgeting:
To help select projects that assist in maximizing the market value of the firm while rejecting projects which do not assist in maximizing value. Only by seeking and accepting projectsthat return an incremental amount above the opportunity cost of capital will the firm beadding to its value.
To estimate the total change in the firm's cash flows that results because a project isundertaken. Hence indirect effects on the costs and/or revenues associated with a firm's other projects that occur as a result of the acceptance of a new project should be considered whenevaluating the cash flows from a new project
Scope of capital Budgeting:
Capital budgeting decision ultimately affects the profitability of the business. Scope of capitalBudgeting may be summarised as follows:
Investment in long term projects or fixed assets is undertaken with a view to expand, or toincrease production or to reduce costs which will lead to increase profits.
The benefits of such investment decisions are likely to accrue in the future after a long periodof time. Apart from the costs of the fixed assets purchased, other costs also increase.
Huge amount of capital outlay are involved when a decision to purchase fixed assets or invest in projects is take.