CAPITAL BUDEGTING.

Sometimes referred to as capital investments planning, capital

expenditures budgeting, strategic planning, or business
programming.

It deals with analyzing the profitability and/or liquidity of an

investment proposal. It is on the following assumptions:
1. Funds are available.
2. Business opportunities (i.e., proper proposals) exist awaiting to
be tapped.
3. Business opportunities are subject to quantitative evaluation.

CHARACTERISTICS
1. It involves material amount of money.
2. It has long-term effects.
3. It directly affects the operating results, and
4. It ends up to a great loss to the enterprise if the decision is
reversed after its implementation.

EXAMPLES OF PORJECTS that need capital budgeting analysis:

1. Long-lived
1.1 Acquire or lease
1.2 Replace or repair
1.3 Improve or outsource
2. Branch operations
2.1 Establish or tap the existing channel of distribution
3. Product management
3.1 Introduce a new product or not
3.2 Conduct the research internally or engage the services of
an outside specialist
4. Technology
4.1 Retain the old technology or introduce a new/modern
technique or technology
4.2 Develop the technology internally or engage the services
of an outside specialist
5. Others
5.1 Research and development
5.2 Exploration
5.3 New projects
 5.4 Internally develop a major marketing program or outsource
services from available service contractors
5.5 Exchange (or trading) of major professional players in
sports business

THE MAIN ACADEMIC ISSUES IN CAPITAL BUDGETING

Net cost of How much is the strategic amount of
investment capital needed?
Net returns How would the investment be
recovered?
Project evaluation Which investment opportunity would
techniques give the highest return on investment,
profitability-wise and/or liquidity-wise
Refinements in How would you reconcile the effects of
capital budgeting the differences of the variations in
evaluation investment amounts, project lives, and
techniques investment risk to make the
comparative analysis of various capital
investment projects more useful?

THE NET COST OF INVESTMENT

1. It is the difference between the relevant cash outflows and the
cash inflows.
2. The tax effects on gain, loss or savings are considered in the
determination of net cost of investment.
3. The gain and loss on disposal of old assets have no direct effect
in the computation of the net cost of investment. However, the
tax effects of the gain and loss on disposal of old asset affect
the cost of investment.
4. The additional working capital is also a cost of investment.
5. The standard guideline in computing the cost of investment in a
new asset shall be:

Easy Ito Company is considering to replace its old equipment with a

new one. The old equipment had a net book value of P100,000 and 4
remaining useful years with P25,000 depreciation each year. The old
equipment can be sold at P80,000. The new equipment costs
P160,000, have a 4-year life. Cash savings on operating expenses
before 40% taxes amount to P50,000 per year.
Required: Caculate the amount of investment in the new equipment.

SOLUTION:
Initial amount of investment 160,000
Less Cash inflows (decrease in outflow) at period 0:
MV of old equipment 80,000
Tax benefits on loss on sales (20,000 x .40) 8,000 88,000
Net Investment 72,000