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Capital Budgeting

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Capital Budgeting

Capital budgeting refers to the decision making process related to long term business

investments. It forms around the basic idea that, funds raised by the company are invested in

assets which will help to generate income for several years. There is need to carefully plan

implementation of capital budgeting since these decisions have an impact on the future of the

company. Similarly capital budgeting is important in terms of timing investments in assets.

For companies to have a higher expected rate of return. Timing of investment decisions is

important. Making early conclusions regarding project investments may cause a lot of

problems because capital budgeting deals with investments in large assets.

Capital budgeting is used when making the following decisions in a firm;

replacement, expansion, independent project and mutually exclusive projects. Replacement

decisions refer to the decision of whether or not the existing machine should be replaced with

an updated version of the same machine or a different machine. These replacements can

either be meant to increase or maintain the level of production in the firm. Expansion

decision concerns the decision if a company should invest in new assets or machines so as to

increase the level of operations. Independent projects refer to projects that the decision of

whether or not investment should be made in the asset is not dependent on any other decision.

For example decision to buy a car visa vie decision of purchasing a music system this are

independent projects. Since there is no relationship between purchase of a car and music

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system. Mutually exclusive projects are projects where the decision to invest in one project

affect investment plans in other projects. For instance if you have decided to purchase a

laptop and you are considering laptops from two different manufacturers (Hp and Toshiba). If

the decision made is to invest in Hp laptop then automatically no investment would be made

in Toshiba. From this example it is clear that by nature of the organization’s decision one

project has to be preferred to the other.

This paper focusses on the decision of whether or not to invest in an independent

project. The company is faced with the dilemma of investment in a new equipment and an

analyst is consulted to determine if the project should be accepted or not. The following

procedure is used to inform this decision.

Investment Costs:

Initial investment $50,000

Consultancy $375

Total $50,375

The total is made up of summation of initial investment and consultancy expenses

since they make up the initial cost of investing in the machine. It is also important to note that

consultancy fee was capitalized.

Derivation of net cash inflows

Cash inflow $45,000

Less Cash outflow $10,000

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Surname 1 Student name: Professor: Course: Date: Capital Budgeting Capital budgeting refers to the decision making process related to long term business investments. It forms around the basic idea that, funds raised by the company are invested in assets which will help to generate income for several years. There is need to carefully plan implementation of capital budgeting since these decisions have an impact on the future of the company. Similarly capital budgeting is important in terms of timing investments in assets. For companies to have a higher expected rate of return. Timing of investment decisions is important. Making early conclusions regarding project investments may cause a lot of problems because capital budgeting deals with investments in large assets. Capital budgeting is used when making the following decisions in a firm; replacement, expansion, independent project and mutually exclusive projects. Replacement decisions refer to the decision of whether or not the existing machine should be replaced with an updated version of the same machine or a different machine. These replacements can either be meant to increase or maintain the level of production in the firm. E ...
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Tags: accounting finance