A STUDY ON CAPITAL BUDGETING METHOD

Introduction:- Capital budgeting is consist two words first is capital and second is budgeting. Capital means cash or goods or assets used to generate income either by investing in a business or a differ income property and budgeting means planning the use of resources allocating them among potential activities to achieve the objectives of the organization. Capital budgeting is the planning process used to determine whether organizations long-term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures. Capital budgeting decisions are those decisions that involve current outlay in return for a series of benefits in coming years. The capital budgeting decisions are often said to be the most important part of corporate financial management. Any decision that requires the use of resources is a capital budgeting decision from broad strategic decision of one extreme to say computerization o the office. The capital budgeting decision is related to the allocation of funds to different long term assets. Broadly speaking the capital budgeting decision denotes a decision situation where the lump-sum funds are invested in the initial stages of a project the returns are expected over a long. Though there is no hard and fast rule to define the long term, yet period involving more than a year may be taken as a long period for investment decision. Capital Project Examples Also identified is a result of risk evaluation or strategic planning. Some typical long-term Capital projects are usually identified by functional needs or opportunities, although many are decisions include whether or not to: Buy new office equipment, cars or trucks; Add to or renovate existing facilities, including the purchase of new capital equipment/machinery; Expand plant or process operations; Invest in facilities for a new product line or to expand services; Continue or discontinue an existing product line; Replace existing capital equipment/machinery with new equipment/machinery; Invest in software to meet technology-based needs or systems designed to help improve process and/or efficiency; Invest in R&D or intangible assets; Build or expanding a foreign or satellite operation; Reorganize assets or services; or, Acquire another company.

The role of finance manager in the capital budgeting, basically lies in the process of capital & in depth analysis & evaluation of various alternative proposals & then to select one out of these. The basic 0bjectives of financial management is to maximize the wealth of the shareholders. Therefore the

objective of capital budgeting is to select those long term investment projects that are expected to make maximum contribution to the wealth of the shareholders in the long run. OBJECTIVES:-Investment decisions are among the firms most difficult decision. They are assessment of future events which are difficult to predict. It is really a complex problem to correctly estimate the future cash flow of an investment. Economic, Political, Social, & Technological forces cause the uncertainty in cash flow estimation. This is the reason for selecting this challenging topic. Conceptual analysis: - Theoretical background the present state of affairs & future approach. Literature review Types of capital budgeting: -Every capital budgeting decision is a specific decision in the given situation for a given firm & with given parameters & therefore an almost infinite number of types or forms of a capital budgeting decision may occur. Even if the same decision being considered by the same firm at two different point of time the decision consideration may change as a result of change as a result of change in one the variables. In general the projects can be categorized as follows (1) From the point of view of firms existence:- Capital budgeting decision s may be taken by a newly incorporated firm or by an already existing firm. (a) New firm:- A newly incorporated firm may be required to take different decision such as selection of a plant to be installed capacity utilization at initial stage .To set up or not simultaneously the acllary unit etc. (b) Existing firm :- A firm which is already existing , may also required to take various decision from to time to meet the challenges of competition or changing environment. This decision may be. Replacement & modernization decision, Expansion & diversification. (2)From the point of view decision situation:- mutually exclusive decision, Accept Contingent decision . (a)mutually exclusive decision:Two or more alternative proposals are said to be mutually exclusive when acceptance of one alternative results in automatic rejection of all other proposals. This decision occurs when a firm has more than alternative but competitive proposals before it. For example selecting one advertising agency to take case of the promotional campaign out rightly rejects all other competitive agencies. Similarly selection of one location out of different feasible location is a mutually exclusive decision (b)Accept reject decision: An accept- reject decision occurs when a proposal is independently. Accepted or rejected without regard to any other alternative proposals. This type of decision is made when (i) proposal s cost & benefit of other proposals, (ii) accepting or rejecting one proposal has not impact on the desirability of other proposal & (iii) the different proposals being considered are not competitive. reject decision &

(c) Contingent decision: - Sometimes a capital budgeting decision is contingent to some other decision for example computerization of a bank branch may require not only air- conditioning but also transfer of some staff member to other branches. Similarly installing a project at some remote location may require expenditure or development of infrastructure also. PROCEDURE OF CAPITAL BUDGETING DECISION It is obvious that the firm must have a systematic procedure for making capital budgeting decision .the procedure must be consistent with the objective of wealth maximization. The procedure must consist of step by step analysis. In the process financial manager undertake the following steps:(a) Estimation of cost & benefits of a proposal: - The most important step required in the capital budgeting decision is to estimate the cost & benefit associate with all the proposals being considered. The cost of proposals is generally the capital expenditure required to install aproject or to implement a decision. However the benefit of proposals may be in the firm of increased output in sales reduction in labor cost reduction in wastages etc. (b) Estimation of the required rate of return :- the rate of return expected from a proposals is to be estimated in order to (i) adjust the future cost & benefit of a proposals for time value of money (ii) Thereafter determine the profitability of the proposals . This required rate of return is also known as cost of capital. Firm should invest the funds in a capital budgeting proposals, only if the return available from investment made elsewhere. This rate of return s known as opportunity cost or minimum required rate of return. It is used as a discount rate in capital budgeting. (c) Using the capital budgeting decision criterion: - A proper capital technique is to be applied to select the best alternative so in the first instance the technique itself is to be selected & then is to be applied for a better decision making. CAPITAL BUDGETING TECHNIQUES OF EVALUTION The attractiveness of any investment proposal depends on the following element (i)The amount expended i.e., the net investment (ii) The potential benefits, the operating cash inflow & (iii) The time period over which these benefits will occur. i.e., Economic life of the project. A proper investment analysis must relate these three elements to provide an indication at whether the investment is worthy at being taken up or not. These techniques can be grouped up in to categories as presented

CAPITAL BUDGETING TECHNIQUES

(a) Traditional or non discounted (I) Pay back period method (ii) Accounting rate of return (b) Time adjusted or discounted (i)Net present value method (ii) Profitibility index (iii) discounted paybackperiodmethod (iv) terminal value (v) Internal rate of return. (c)