Factors affecting Capital Budgeting Decisions PDF

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Summary

Capital budgeting is a decision-making process used by businesses to determine which capital-intensive initiatives they should undertake. Decisions regarding opening a new factory, expanding the workforce, entering a new market, or researching and developing new goods are all examples of capital bud...

Description

CAPITAL BUDGETING: Capital budgeting is a decision-making process used by businesses to determine which capital-intensive initiatives they should undertake. Opening a new factory, expanding the workforce, entering a new market, or researching and developing new goods are all examples of capital-intensive initiatives. If such expenditures are deemed worthwhile is determined by the company's strategy to evaluating them. Capital budgeting is used in this situation. For example, a corporation could decide to value its projects based on its internal rate of return, net present value, payback periods, or a mix of these factors.

Factors affecting Capital Budgeting Decisions: 1. Funding Availability: Each project will require a different degree of expenditure. Certain initiatives demand a large sum of money and have a high profit margin. If the corporation lacks sufficient cash, such initiatives may be abandoned.

2. Requirement for a minimum rate of return on investment Each management team anticipates a minimal rate of return or break-even point on capital investments. It refers to the point at which a project is deemed unacceptable.

3. Prospective Earnings

Earnings in the future may be consistent or variable. Even so, the corporation anticipates assured future revenues in aggregate, which influences the project selection process.

4. Inflows of cash Cash inflows is a word that refers to earnings after taxes but before depreciation. The reason for this is that depreciation is recorded as a book item and there is no associated cash outflow. As a result, the amount of depreciation is included in the cash inflow.

5. Legal Obligations While selecting a project, management should keep legal requirements in mind. In the leather and chemical sectors, several legislative restrictions have been enacted to safeguard the environment from pollution. Now, management places a higher premium on legal provisions than on cost and profit.

6. Projects of Research and Development For technology-based enterprises, research and development projects are critical. The reason for this is because technology undergoes rapid development in a short period of time. In the long term,

the

research

and

development

effort

yield

greater

advantages. Thus, profitability takes a back seat to corporate survival in the case of research and development projects.

7. Capital Investment Proposal Ranking Occasionally, a business will have two or more profitable initiatives in the works. If there is just one lucrative project among several others and a large sum of money is available to management, there is no need to rate capital investment proposals. Ranking is important when management has a large number of profitable initiatives on the go and only a limited amount of funding accessible.

8. Profitability Quantum Expected It is required to determine the anticipated profit from the implementation of the chosen project. Profit refers to the money realised on projects as recorded in accounting records.

9. Risk and Uncertainty Each plan has some risk and uncertainty as a result of economic conditions, competition, demand and supply situations, and customer preferences, among other factors. The degree of risk and uncertainty in a project has an effect on its profitability. As a result, the degree of risk and uncertainty associated with the project is considered throughout the selection process.

10. Importance A project may be chosen instantly in response to an emergency or a sense of urgency. The rationale for this is that such rapid

selection saves the company's life, implying that the survival of the business takes precedence above all other considerations.

11. Oblivion Replacement of existing fixed assets is required due to plant and machinery obsolescence.

12. Activities of Competitors Every business should keep an eye on its rivals' activity. The corporation should make a judgement in light of its rivals' activity. If this is the case, the business can compete successfully by adopting new projects.

13. Intangibles Instead of focusing just on profit, the company's reputation, industry

relationships,

employee

safety,

and

welfare

are

considered while picking a project. These criteria also play a significant role in the selection of any project.

Thus, there are various factors that may affect the capital budgeting decision....