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MODULE – 5

MANAGEMENT OF
FUNDS:

Capital Budgeting
By.,

Yathiraju K
Asst. Professor
Dept. of Commerce
Christ University
Bangalore- 29

 Capital budgeting is a process of planning that is used to ascertain the long-term investments of the firm.CONCEPT OF CAPITAL BUDGETING  Capital budgeting is the process of making investment decision in capital expenditure. new products and the research and development projects. new plants.  The long-term investment of a firm may be for new machinery. replacement machinery. .

"According to Charles T Horn Green capital budgeting is long term planning for making & financial proposed.MEANING AND DEFINITION The term capital budgeting means planning for capital assets. the benefits of which are expected to be received over a period of time exceeding one year." . A capital Expenditure is an expenditure. Capital outlays. In other words “Planning the deployment of available capital for the purpose of maximizing the long term profitability of a firm.

long term investment that can’t be reversed or with drawn without sustaining loss. Capital Expenditure once approved represent. 6. Any error in evaluation leads to heavy loss in investments. Preparation of capital Budget plans involves forecasting of several years profit in advance in order to judge the profitability of projects. 4. . The exchange of current funds for future benefit. 3. The funds are invested in long-term assets.FEATURES OF INVESTMENTS DECISIONS 1. 2. 5. The future benefits will occur to the firm over a series of year.

IMPORTANCE DECISIONS OF INVESTMENT 1) They influence the firm’s growth in the long run 2) They affect-risk of the firm 3) They involve commitment of large funds. . 4) They have a long term effect on profitability 5) They are irreversibly in nature / reversible at substantial loss 6) They are among the complex decisions to make 7) They are of national importance.

PRINCIPLES OF CAPITAL BUDGETING DECISIONS  Cost  Surplus  Large Investment  Long term effect on profitability  Long term commitment of funds  Time  Risk  Invariability  Complexity .

CAPITAL BUDGETING PROCESS .

c) Capital rationing decisions 3 On the basis of firm’s existence: a) Replacement and Modernization decisions b) Expansion decisions c) Diversification decisions . Based on a profitability: a) Those which increase Revenue b) Those which reduces cost.KINDS OF INVESTMENT DECISION 1. 2. Based on the proposal under consideration: a) Accept reject decision. b) Mutually exclusive project decision.

Estimation of cash flows. 2. 1. Estimation of the required rate of return 3.INVESTMENT EVALUATION CRITERIA: 3 Steps are involved in the evaluation of an investment. Application of a decision rule for making the choice .

b) Improvement of traditional Approach c) Rate of Return method / accounting Method Time adjusted method/Discounted Method a) Net Present Value method b) Internal Rate of Return method c) Profitability Index method .METHOD OF EVALUATION OF INVESTMENT PROPOSALS Traditional Methods a) Pay back method / Pay out or Pay off method.