Professional Documents
Culture Documents
CAPITAL BUDGETING
CAPITAL BUDGETING
• Planning and control of capital expenditures, this activity is essential
because it provides a systematic evaluation of the firm’s alternatives.
• Is the planning process used to determine whether an organization's
long term investments such as new machinery, replacement of
machinery, new plants, new products, and research development
projects are worth the funding of cash through the firm's capitalization
structure (debt, equity or retained earnings). It is the process of
allocating resources for major capital, or investment, expenditures.
• One of the primary goals of capital budgeting investments is to increase
the value of the firm to the shareholders.
• 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 that the business will have little chance of
surviving in the competitive marketplace.
BASIC TERMS IN CAPITAL BUDGETING
1. Capital Expenditures
2. Capital Budgeting
3. Valuation
4. Investments
CAPITAL EXPENDITURES
• Refers to substantial outlay of funds the purpose of which to
lower costs and increase net income for several years in the
future. It includes expenditures that tie up capital inflexibility
for long periods.
• Is the money a company spends to buy, maintain, or improve
its fixed assets, such as buildings, vehicles, equipment, or land.
• It is considered a capital expenditure when the asset is newly
purchased or when money is used towards extending the
useful life of an existing asset, such as repairing the roof.
CLASSES OF CAPITAL EXPENDITURES
• REPLACEMENT INVESTMENTS- refers to investments on replacement of worn-
out or obsolete facilities.
• EXPANSION INVESTMENTS-type of expenditure will provide additional facilities
to increase the production or distribution capabilities of the firm.
• PRODUCT-LINE OR NEW MARKET INVESTMENTS-refers to expenditures on new
products or new markets, and on improvement of old products with the
combined features of replacement and expansion investments.
• INVESTMENTS IN SAFETY AND/OR ENVIRONMENTAL PROJECTS-are
expenditures necessary to comply with government orders, labor agreements,
or insurance policy terms.
• STRATEGIC INVESTMENTS-are investments designed to accomplish the overall
objectives of the firm.
• OTHER INVESTMENTS- catch all the term includes office, buildings, parking lots,
executive aircraft.
VALUATION
• In finance, valuation is the process of determining the present
value (PV) of an asset. Valuations can be done on assets (for
example, investments in marketable securities such
as stocks, options, business enterprises, or intangible
assets such as patents and trademarks) or on liabilities
(e.g., bonds issued by a company). Valuations are needed for
many reasons such as investment analysis, capital
budgeting, merger and acquisition transactions, financial
reporting, taxable events to determine the proper tax liability,
and in litigation.
• When the proposal’s is real worth to the firm is determined.
INVESTMENT
• Is made when a firm spends some of its funds for the
establishment of a project. By doing so, the opportunity
to use the same funds in the other project is lost.
• TWO FORMS OF INVESTMENTS:
1. INITIAL INVESTMENT-refers to the amount that has
been devoted to a project until it generates cash
inflows from operations.
2. LATER INVESTMENT-expenditures made after the first
cash inflow.
OBJECTIVES OF CAPITAL BUDGETING
A. Establishing priorities;
B. Cash planning;
C. Construction planning
D. Eliminating duplication; and
E. Revising plans.
CONSTRUCTION PLANNING
• The objective of construction planning is to minimize the period
expended for the construction or acquisition of a capital asset.
ELIMINATING DUPLICATION
• A centralized capital budgeting activity will help identify efforts
undertaken at various levels in a decentralized organization.
ESTABLISHING PRIORITIES