Capital Budgeting

Decide how to invest money

so that its value is maximized

 Steel plant is considering building a new

heating system
An insurance company is planning to install
a computer system for information
processing
Manufacturing unit is looking for acquiring
a small unit which is in the same line of
business
....capital

expenditure decision!!!

Capital Investments
Physical Assets: Land, building, plant,
machinery, vehicles and computers.
Monetary Assets: financial claims against
some parties. Deposits, bonds and equity
shares
Intangible Assets: they represent outlays
on R&D, training, market development,
franchises & so on.

Capital Investments are also of

Strategic Investments: significant impact
on the direction of the firm
Tata Motors
Decision to invest in car passenger
Tactical Investments: implement a current
strategy as efficiently or as profitably as
possible
Decision to replace an old machine to
Tata Motors
improve productivity

Capital investments are often

classified by companies in
different categories for planning
& control

 Mandatory investment: to meet statutory requirements

Ex: Pollution control equipment, fire fighting equipment,
medical dispensary
Replacement investment: replace worn out equipment to
reduce cost & increase productivity, quality.
Expansion investment: increase the capacity to meet
growing demand
Diversification investment: to increase new products or
services or entering into new geographical areas.
R & D investment: to develop new products & processes
which would sharpen the technological edge of the firm
Miscellaneous investments: catch-all category.
Ex: interior decoration, recreational facilities, landscaped
gardens.

Meaning of Capital Budgeting

Capital budgeting addresses the issue of strategic
long-term investment decisions.
Capital budgeting can be defined as the process of
analyzing, evaluating, and deciding whether
resources should be allocated to a project or not.
Process of capital budgeting ensure optimal
allocation of resources and helps management
work towards the goal of shareholder wealth
maximization.

Capital Budgeting Process

Capital budget (investment) proposals
are examined on basis of their cash
outlays and resulting flow of future
benefits over period of time greater
than one year.

Capital Budgeting Process

1. Identify alternative investment
opportunities and the capital
required for each one.
2. Assess organizations ability to
generate investment capital for
capital budgeting period

Capital Budgeting Process

3. Measure cash

(benefit) flows
from alternative
capital investment
opportunities
4. Evaluate
proposals using
selected criteria

Increase log inventory to

reduce risk of mill downtime
during Spring breakup?

Capital Budgeting Process

5. Select alternatives to fund and implement
6. Review performance for feed-back
to decision makers
Buy new skidder
to reduce
maintenance cost
on old one and
increase
productivity?

Significance of Capital
Budgeting
Considered to be the most important
decision that a corporate treasurer has to
make.
So much is the significance of capital
budgeting that many business schools offer
a separate course on capital budgeting

Why Capital Budgeting is so

Important?

Involve massive investment of resources

Are not easily reversible
Have long-term implications for the firm
Involve uncertainty and risk for the firm

Levels of Decision Making

Operating Ex: Minor office equipment
Administrative Ex: Balancing equipment
Strategic Ex: Diversification project

Answer these questions(OAS)

Where is the decision taken ?

How structured is the decision?
What is the level of resource commitment?
What is the time horizon?