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Importance of Capital budgeting:

(1) There is a positive correlation between the sale of the product of the firm and the current

assets. An increase in the sale of the project requires a corresponding increase in current

assets. It is, therefore, indispensable to manage the current assets properly and efficiently.

(2) More than half of the total capital of the firm is generally invested in current assets. It

means less than half of the capital is blocked in fixed assets. We pay due attention to the

management of fixed assets in details through the capital budgeting process. Management of

working capital too, therefore, attracts the attention of the management.

(3) In emergency (Non availability of funds etc.) fixed assets can be acquired on lease but

there is no alternative for current assets. Investment in current assets, i.e., inventory or

receivable, can in no way be avoided without sustaining loss.

(4) Working capital needs are more often financed through outside sources, so it is necessary

to utilise them in the best way possible.

Need of capital budgeting:

1. Analysis of capital expenditure

2.Selection of best alternative

3.coordination among various outlays

4.control on capital expenditure

5.avoidance of losses

6.Analysis of risk and uncertainity

7. Arrangement of funds

WHAT IS CAPITAL BUDGETING ?capital budgeting decisions may be defined as the firms decision to invest it current funds most

effectively in long term activities in anticipation of an expected flow of future benefits over a series of

years.

The future benefits may be in term of reduced costs, increased revenue, simplification of the process,

enhancement of quality etc.

Capital budgeting decision includes purchase and sale of assets, replacement of old assets by a new

one, having assets on lease, implementation of new projects. Capital expenditure decision, capital

expenditure management, long term investment decision. Management of fixed assets etc. is other

name of capital budgeting decision.

FEATURE OF CAPITAL BUDGETING DECISION:a) The important features of capital budgeting decision may be enumerated as follows

b) Funds are invested in current period in order to obtain future benefits.

c) Future benefits are obtained over a series of year and only in one year.

d) Often there is relatively a long time lag between the initial outlay and getting the first return.

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e) A relatively higher degree of risk is involved in capital budgeting as many factors may change in

future.

f) Expenditure related to an investment and the benefits received from such investment should be

measured in terms of cash flow and not in terms of accounting profits.

g) Selection of a profitable investment satisfies objectives of shareholders wealth maximization

thereby maximizing the value of the term.

SIGIFICANCE OF CAPITAL BUDGETING

Capital budgeting is very important to a firm and there is need for capital budgeting for the following

reasons-

Capital budgeting decision has long term significance. The effect of capital budgeting decision will

persist in the long run. Hence any wrong decision is taken its burden will have to be borne for a long

period of time. The future prospect of a firm depends mainly on its capital expenditure. The firm can

earn huge profits if it can make appropriate capital expenditure at the appropriate time. Hence the firm

should have sufficient thinking and consideration before such decisions.

Capital expenditure decision generally involve large sum of money. Such investment give returns for a

long period of time but to procure such assets, a firm has to invest large sum of money. So before

making such investment, the firm has to take sufficient care and make arrangement for collecting

large funds.

Capital budgeting decision is irreversible in most cases. If a machine on capital goods is once

purchase it is difficult to get back the money by reselling it because such capital goods have very

limited market. Hence, in many cases the firm has no other alternative but to scrap the capital goods

on sell it at throw away price.

Capital expenditure requires huge money. No firm has unlimited money. If the money is invested

wrongly not only the firm losses, it will also be deprived of the profits it could have obtained from the

alternative use of that money.

Capital budgeting is important because they are the most difficult decision to make. To make such

decision one has to forecast future events and future income and expenditure. The future returns from

an investment cant always be expressed in money terms.

Due to a particular capital budgeting decision the firms risk may increase. Suppose, due to an

acceptance of an investment proposal, the firm income increased, but at the same time fluctuation in

income also increased, in that case, both income and risk of the firm increased. The future cost

structure of the firm is also related to the capital budgeting decisions.