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.
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.

Definitions
According to the definition of Charles T. Hrongreen, “capital budgeting is a long-term
planning for making and financing proposed capital out lays.
According to the definition of G.C. Philippatos, “capital budgeting is concerned with
the allocation of the firms source financial resources among the available opportunities.
The consideration of investment opportunities involves the comparison of the expected
future streams of earnings from a project with the immediate and subsequent streams of
earning from a project, with the immediate and subsequent streams of expenditure”.
According to the definition of Richard and Green law, “capital budgeting is acquiring
inputs with long-term return”.
According to the definition of Lyrich, “capital budgeting consists in planning
development of available capital for the purpose of maximizing the long-term profitability
of the concern”.

It is clearly explained in the above definitions that a firm’s scarce financial resources
are utilizing the available opportunities. The overall objectives of the company from is to
maximize the profits and minimize the expenditure of cost.
Need and Importance of Capital Budgeting
1. Huge investments: Capital budgeting requires huge investments of funds, but
the available funds are limited, therefore the firm before investing projects, plan
are control its capital expenditure.
2. Long-term: Capital expenditure is long-term in nature or permanent in nature.
Therefore financial risks involved in the investment decision are more. If higher
risks are involved, it needs careful planning of capital budgeting.
3. Irreversible: The capital investment decisions are irreversible, are not changed
back. Once the decision is taken for purchasing a permanent asset, it is very
difficult to dispose off those assets without involving huge losses.
4. Long-term effect: Capital budgeting not only reduces the cost but also increases
the revenue in long-term and will bring significant changes in the profit of the
company by avoiding over or more investment or under investment. Over
investments leads to be unable to utilize assets or over utilization of fixed assets.
Therefore before making the investment, it is required carefully planning and
analysis of the project thoroughly.

CAPITAL BUDGETING PROCESS
Capital budgeting is a difficult process to the investment of available funds. The benefit
will 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 are.
Identification of Various Investments

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 department analyse the various investment decisions, and
will select proposals submitted to the planning committee of competent authority.
2. Screening or matching the proposals: The planning committee will analyse the
various proposals and screenings. 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.

3. Evaluation: After screening, the proposals are evaluated with the help of various
methods, such as pay back period proposal, net discovered present value method,
accounting rate of return and risk analysis. Each method of evaluation used in
detail in the later part of this chapter. The proposals are evaluated by.
(a) Independent proposals
(b) Contingent of dependent proposals
(c) Partially exclusive proposals.
Independent proposals are not compared with another proposals and the same
may be accepted or rejected. Whereas higher proposals acceptance depends upon
the other one or more proposals. For example, the expansion of plant machinery
leads to constructing of new building, additional manpower etc. Mutually exclusive
projects are those which competed with other proposals and to implement the
proposals after considering the risk and return, market demand etc.

4. Fixing property: After the evolution, the planning committee will predict which
proposals will give more profit or economic consideration. If the projects or
proposals are not suitable for the concern’s financial condition, the projects are
rejected without considering other nature of the proposals.
5. Final approval: The planning committee approves the final proposals, with the
help of the following:
(a) Profitability
(b) Economic constituents
(c) Financial violability
(d) Market conditions.

The planning committee prepares the cost estimation and submits to the
management.
6. Implementing: The competent autherity 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.
122 Financial Management
7. Performance review of feedback: The final stage of capital budgeting is actual
results compared with the standard results. The adverse or unfavourable results
identified and removing the various difficulties of the project. This is helpful for
the future of the proposals.