ICCT COLLEGES FOUNDATION INC.

CAE13-FINANCIAL MANAGEMENT

Villariez Jr, Baltazar D. 20185539 Mrs. Ostan

ASSIGNMENT/ACTIVITY-CHAPTER 7

1. What do you mean by capital budgeting?

2. How capital budgeting is helpful for decision making?
3. Discuss the capital budgeting process.

ANSWERS:
1. Capital budgeting is the process a business undertakes to evaluate potential
major projects or investments. Construction of a new plant or a big investment in
an outside venture are examples of projects that would require capital budgeting
before they are approved or rejected.
As part of capital budgeting, a company might assess a prospective project's
lifetime cash inflows and outflows to determine whether the potential returns that
would be generated meet a sufficient target benchmark. The capital budgeting
process is also known as investment appraisal.

2. Capital budgeting is important because it creates accountability and

measurability. Any business that seeks to invest its resources in a project without
understanding the risks and returns involved would be held as irresponsible by its
owners or shareholders.

Furthermore, if a business has no way of measuring the effectiveness of its

investment decisions, chances are the business would have little chance of
surviving in the competitive marketplace.

Businesses (aside from non-profits) exist to earn profits. The capital budgeting
process is a measurable way for businesses to determine the long-term
economic and financial profitability of any investment project.
3. The Capital Budgeting process is the process of planning which is used to
evaluate the potential investments or expenditures whose amount is significant. It
helps in determining the company’s investment in the long term fixed assets such
as investment in the addition or replacement of the plant & machinery, new
equipment, Research & development, etc. This process the decision regarding
the sources of finance and then calculating the return that can be earned from
the investment done.

Following are the steps of capital budgeting process:

 Idea Generation
The most important step of the capital budgeting process is generating good
investment ideas. These investment ideas can come from a number of
sources like the senior management, any department or functional area,
employees, or sources outside the company.

 Analyzing Individual Proposals

A manager must gather information to forecast cash flows for each project in
order to determine its expected profitability. This is because the decision to
accept or reject a capital investment is based on such an investment’s future
expected cash flows. 

 Planning Capital Budget

An entity must give priority to profitable projects as per the timing of the
project’s cash flows, available company resources, and a company’s overall
strategies. The projects that look promising individually may be undesirable
strategically. Thus, prioritizing and scheduling projects is important because
of the financial and other resource issues. 

 Monitoring and Conducting a Post Audit

It is important for a manager to follow up or track all the capital budgeting
decisions. He should compare actual with projected results and give reasons
as to why projections did not match with actual performance. Therefore, a
systematic post-audit is essential in order to find out systematic errors in the
forecasting process and hence enhance company operations.