Concept of Capital Budgeting: Capital Budgeting Is A Process of Planning That Is Used To Ascertain
Concept of Capital Budgeting: Capital Budgeting Is A Process of Planning That Is Used To Ascertain
Concept of Capital Budgeting: Capital Budgeting Is A Process of Planning That Is Used To Ascertain
IMPORTANCE OF CAPITAL
BUDGETING
1. Long-term Implications:
A capital budgeting decision has its effect over a long time span
and inevitably affects the company’s future cost structure and
growth. A wrong decision can prove disastrous for the long-term
survival of firm. On the other hand, lack of investment in asset
would influence the competitive position of the firm. So the capital
budgeting decisions determine the future destiny of the company.
3. Irreversible decisions:
5. Difficult to make:
TECNIQUES OF CAPITAL
BUDGETING
1. Payback Period Approach
Formula / Equation:
The formula or equation for the calculation of payback period is as
follows:
Payback period = Investment required / Net annual cash
inflow*
Example:
York company needs a new milling machine. The company is
considering two machines. Machine A and machine B. Machine A
costs $15,000 and will reduce operating cost by $5,000 per year.
Machine B costs only $12,000 but will also reduce operating costs
by $5,000 per year.
Required:
Calculation:
There are two variants of the accounting rate of return (a) Original
Investment Method, and (b) Average Investment Method.
It is clear from the above discussion that the system is not much
useful except in evaluating the long-term capital proposals.