Course Name : Master of Business Administration

Semester Number : II Semester

Subject Code : KMBN204
FINANCIAL MANAGEMENT AND
Subject Name :
CORPORATE FINANCE
Faculty Name : DR. SOFIA KHAN
Designation : Assistant Professor
Institution : School of Management Sciences, Varanasi
Capital Budgeting: Meaning, Nature, Definition,
Topic :
Kinds and Process
 CAPITAL BUDGETING
 Itis derived from two words Capital and
Budgeting:

CAPITAL CAPITAL
BUDGETING
BUDGETING

KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE

 CAPITAL BUDGETING
 The word Capital refers to be the total
investment of a company of firm in
money, tangible and intangible assets.
 Whereas budgeting defined by the
“Rowland and William” it may be said to
be the art of building budgets. Budgets are
a blue print of a plan and action expressed
in quantities and manners.
KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE
 CAPITAL BUDGETING
 The examples of capital expenditure:
 1. Purchase of fixed assets such as land and
building, plant and machinery, good will, etc.
 2. The expenditure relating to addition, expansion,
improvement and alteration to the fixed assets.
 3. The replacement of fixed assets.
 4. Research and development project.

KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE

Definition of Capital budgeting
According to • Capital budgeting is a long-term planning for
Charles T. making and financing proposed capital
Horngreen outlays.

According to
• Capital budgeting is concerned with the
G.C. Philippatos allocation of the firm’s source financial
resources among the available opportunities.
In the words of • Capital budgeting is acquiring inputs with
Richard and
Green law long-term return.
• Capital budgeting consists in planning
According to development of available capital for the purpose
Lyrich of maximizing the long-term profitability of
the concern.

KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE

 Nature of Capital Budgeting
 Capital budgeting is the process of making investment
decisions in capital expenditures. A capital expenditure may be
defined as an expenditure the benefits of which are expected to
be received over period of time exceeding one year.
 In simple language we may say that a capital expenditure is
an expenditure incurred for acquiring or improving the fixed
assets, the benefits of which are expected to be received over a
number of years in future.
 Capital expenditure involves non-flexible long-term
commitment of funds. Thus, capital expenditure decisions are
also called as long-term investment decisions.
KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE
 Nature of Capital Budgeting
 Capitalbudgeting involves the planning and control
of capital expenditure. It is the process of deciding
whether or not to commit resources to a particular
long-term project whose benefits are to be realized over
a period of time, longer than one year.
 Capital budgeting is also known as Investment
Decision Making, Capital Expenditure Decisions,
Planning Capital Expenditure and Analysis of
Capital Expenditure.

KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE

 KINDS OF CAPITAL BUDGETING DECISIONS
 The overall objective of capital budgeting is to maximize the
profitability.
 If a firm concentrates return on investment, this objective
can be achieved either by increasing the revenues or reducing
the costs.
 The increasing revenues can be achieved by expansion or the
size of operations by adding a new product line. Reducing
costs mean representing obsolete return on assets.
 Following are the main kinds of capital budgeting decisions:
KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE
KINDS OF CAPITAL BUDGETING DECISIONS
• Two or more proposals are said to be mutually
Mutually
exclusive proposals when acceptance of one
Exclusive
proposal results in automatic rejection of all
Decisions:
other proposals. “Only the Best One Selected”
• Two or more proposals are said to be
Complimentary when acceptance of one proposal
Complimentary implies automatic acceptance of all
Decisions: complimentary proposals and rejection of one
proposal implies automatic rejection of all
complimentary proposals.
Independent • Two or more proposals are said to be Independent
Proposal or when acceptance/rejection of one proposal does
Accept - Reject not affect the acceptance/ rejection of other
Proposal: proposals. “All the Good One Selected”

KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE

PROCESS OF CAPITAL BUDGETING DECISIONS

 Capitalbudgeting is a difficult process

to the investment of available funds.
The benefit will be attained only in the
near future but, the future is uncertain.
However, the following steps followed
for capital budgeting, then the process
may be easier-

KMBN204: FINANCIAL MANAGEMENT

AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
1. Identification of various investments proposals

2. Screening or matching the proposals

3. Evaluation

4. Fixing priority

5. Final approval & preparation of capital expenditure budget

6. Implementing

7. Performance review of feedback

KMBN204: FINANCIAL MANAGEMENT
AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
 1. Identification of various investments
proposals: The capital budgeting may have
various investment proposals. The proposal for
the investment opportunities may be defined
from the top management or may be even from
the lower rank. The heads of various
departments, analyze the various investment
decisions, and will select proposals submitted to
the planning committee of competent authority
or capital expenditure planning committee.
KMBN204: FINANCIAL MANAGEMENT
AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
 2. Screening or matching the proposals: The planning
committee will analyze the various proposals and do
the screenings. They analyze it from various angles
to insures that these are in accordance with the
corporate strategies, selection criterion of a firm and
do not lead to departmental imbalances. The selected
proposals are considered with the available resources of
the concern. Here resources referred as the financial
part of the proposal. This reduces the gap between the
resources and the investment cost.
KMBN204: FINANCIAL MANAGEMENT
AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
 3. Evaluation: After screening, the proposals are evaluated
with the help of various methods, such as payback period
proposal, net discovered present value method, accounting
rate of return , internal rate of return method and risk
analysis. Each method of evaluation used in detail in the
later part of this unit. The proposals are evaluated by.
 (a) Independent proposals
 (b) Contingent of dependent proposals
 (c) Partially exclusive proposals.
KMBN204: FINANCIAL MANAGEMENT
AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
 4.Fixing priority: After the evaluation, the planning
committee accepts the proposals which give more profit or
economic consideration and reject the unprofitable and
uneconomical proposals.
 As it may not be possible for the firm to invest
immediately in all the acceptable proposals due to
limitations of funds, hence it is very essential to rank
the various proposals and to establish priorities after
considering risk, profitability and cost involved therein.
KMBN204: FINANCIAL MANAGEMENT
AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
 5. Final approval & preparation of capital expenditure budget:
The planning committee approves the final proposals, with the
help of the following factors:
 (a) Profitability
 (b) Economic constituents
 (c) Financial violability
 (d) Market conditions.
The planning committee prepares the cost estimation and
submits to the management.
KMBN204: FINANCIAL MANAGEMENT
AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS
 6.Implementing: The competent authority spends the
money and implements the proposals. While
implementing the proposals, assign responsibilities to
the proposals, assign responsibilities for completing it,
within the time allotted and reduce the cost for this
purpose. The network techniques used such as PERT
and CPM. It helps the management for monitoring
and containing the implementation of the proposals.

KMBN204: FINANCIAL MANAGEMENT

AND CORPORATE FINANCE
PROCESS OF CAPITAL BUDGETING DECISIONS

7. Performance review of feedback: The final

stage of capital budgeting is actual results
compared with the standard results. The
adverse or unfavorable results identified and
removing the various difficulties of the project.
This is helpful for the future of the proposals.

KMBN204: FINANCIAL MANAGEMENT

AND CORPORATE FINANCE
KMBN204: FINANCIAL MANAGEMENT AND CORPORATE FINANCE