Hello, What is Financial decision and investment decision? Capital Budgeting: Principles and techniques – Nature of capital budgeting- Identifying relevant cash flows – Evaluation Techniques: Payback, Accounting rate of return, Net Present Value, Internal Rate of Return, Profitability Index – Comparison of DCF techniques – Project selection under capital rationing – Inflation and capital budgeting – Concept and measurement of cost of capital – Specific cost and overall cost of capital.
What is Financial decision and investment decision
1. Nature of capital budget:
Capital budgeting is the process of making investment decisions in capital expenditure. An item of capital expenditure can be defined as an expense whose benefits are expected to accrue over a period of more than one year.
The main feature of capital expenditure is that expenditure is made at one time while the benefit of expenditure is received at different points of time in the future. In simple language, we can say that capital expenditure is an expenditure incurred for the acquisition or improvement of immovable properties, which is expected to be realized in several years in the future.
2. Need and Importance of Capital Budgeting:
The need, importance, or importance of capital budgeting arises mainly due to the following.
1. Large Investment:
Capital budget decisions typically involve a large investment of money. But the funds available with the firm are always limited. And the demand for funds is more than resources. Therefore, it is very important for a firm to plan and control its capital expenditure.
2. The long-term commitment of the fund:
Capital expenditure includes not only a large amount of money but also long-term or short or long-term money on a permanent basis. The long-term commitment of funds increases the financial risk involved in investment decisions. The greater the risk involved, the more capital expenditure requires careful planning, namely capital budgeting.
3. Immutable nature:
Capital expenditure decisions are irreversible in nature. Once it is decided to obtain permanent assets, it becomes very difficult to dispose of these assets without incurring heavy losses.
4. Long-term impact on profitability:
Capital budget decisions have a long-term and significant impact on the profitability of a concern. Not only is the firm’s current income affected by investment in capital assets, but the firm’s future growth and profitability also depend on the investment decision taken today. A mindless decision can prove disastrous and fatal to the very existence of anxiety. Capital budgeting is highly important to avoid fixed investment or investment in fixed assets.
5. Difficulties of investment decisions:
- It is difficult to take long-term investment decisions because:
- The decision spans a series of years beyond the current accounting period,
- Uncertainty of future and
- High level of risk.
6. National Importance:
The investment decision taken due to personal concern is of national importance as it determines employment, economic activities, and economic development. Thus, we can say that a firm can involve itself in a losing project without using capital budgeting techniques. Proper timing of purchase, replacement, expansion, and repatriation of assets is required.
3. Capital budget limits:
Capital budgeting techniques suffer from the following limitations:
- All techniques of capital budgeting assume that the various investment proposals under consideration are mutually exclusive which may not be practically correct under certain special circumstances.
- Capital budgeting techniques require the estimation of future cash flows and outflows. The future is always uncertain and the data collected for the future may not be accurate. Results may not be good based on unclear data.
- There are some factors like the morale of employees, goodwill of the firm, etc., which cannot be determined correctly, but which would otherwise significantly affect the capital decision.
- There is another limitation in the evaluation of capital investment decisions.
- Uncertainty and Risk is the biggest limitation of capital budgeting techniques.
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Business management expert and Leadership Consultant and Business Coach, who writes her blog, Jay’s Trends, focused on helping small business owners understand trends in Business management. Other posts by Jayprakash Prajapati»