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Introduction
The word Capital refers to be the total investment of a company of firm in money, tangible and intangible assets. Whereas budgeting defined by the “Rowland and William” it may be said to be the art of building budgets. Budgets are a blue print of a plan and action expressed in quantities and manners.
The examples of capital expenditure:
- Purchase of fixed assets such as land and building, plant and machinery, good will,etc.
- The expenditure relating to addition, expansion, improvement and alteration to the fixed assets.
- The replacement of fixed assets.
- Research and development project.
Definitions
According to the definition of Charles T. Hrongreen, “capital budgeting is a long-term planning for making and financing proposed capital out lays.
According to the definition of G.C. Philippatos, “capital budgeting is concerned with the allocation of the firms source financial resources among the available opportunities. The consideration of investment opportunities involves the comparison of the expected future streams of earnings from a project with the immediate and subsequent streams of earning from a project, with the immediate and subsequent streams of expenditure”.
According to the definition of Richard and Green law, “capital budgeting is acquiring inputs with long-term return”.
According to the definition of Lyrich, “capital budgeting consists in planning development of available capital for the purpose of maximizing the long-term profitability of the concern”.
It is clearly explained in the above definitions that a firm’s scarce financial resources areutilizing the available opportunities.The overall objectives ofthe company from is to maximize the profits and minimize the expenditure of cost.
Need and Importance of Capital Budgeting
- Huge investments: Capital budgeting requires huge investments of funds, but the available funds are limited,therefore the firmbefore investing projects, plan are control its capital expenditure.
- Long-term: Capital expenditure is long-term in nature or permanent in nature. Therefore financial risks involved in the investment decision are more. If higher risks are involved, it needs careful planning of capital budgeting.
- Irreversible: The capital investment decisions are irreversible, are not changed back. Once the decision is taken for purchasing a permanent asset, it is very difficult to dispose off those assets without involving huge losses.
- Long-term effect: Capital budgeting not only reduces the cost but also increases the revenue in long-term and will bring significant changes in the profit of the company by avoiding over or more investment or under investment. Over investments leads to beunable to utilize assets or over utilization offixed assets. Therefore before making the investment, it is required carefully planning and analysis of the project thoroughly.
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FAQs on Introduction - Capital Budgeting, Accountancy and Financial Management - Accountancy and Financial Management - B Com
| 1. What is capital budgeting? |  |
Ans. Capital budgeting refers to the process of evaluating and selecting long-term investment projects that are expected to generate positive cash flows and contribute to the overall growth and profitability of a company. It involves analyzing the potential risks and rewards associated with different investment opportunities to determine which projects should be pursued.
| 2. What is the role of accountancy in capital budgeting? | |
Ans. Accountancy plays a crucial role in capital budgeting as it provides the necessary financial information and analysis required for decision making. Accountants help in estimating cash flows, calculating relevant financial metrics such as net present value (NPV) and internal rate of return (IRR), and assessing the financial viability of investment projects. They also ensure that the budgeting process adheres to accounting principles and standards.
| 3. How does financial management contribute to capital budgeting decisions? | |
Ans. Financial management plays a key role in capital budgeting decisions by providing the framework and tools necessary for evaluating investment opportunities. It involves assessing the cost of capital, determining the appropriate discount rate, and considering the time value of money. Financial managers also consider the company's overall financial strategy, risk tolerance, and the impact of investment decisions on the company's financial position and performance.
| 4. What are the key factors to consider in capital budgeting? | |
Ans. Several key factors need to be considered in capital budgeting decisions. These include:
- Cash flows: The expected cash inflows and outflows associated with the investment project.
- Risk and uncertainty: The level of risk and uncertainty associated with the project's cash flows.
- Time value of money: The concept that a dollar received in the future is worth less than a dollar received today.
- Cost of capital: The required rate of return or discount rate used to calculate the present value of future cash flows.
- Strategic fit: The alignment of the investment project with the company's overall strategic objectives and long-term goals.
| 5. What are some commonly used capital budgeting techniques? | |
Ans. There are several commonly used capital budgeting techniques, including:
- Net Present Value (NPV): This technique calculates the present value of expected future cash flows and subtracts the initial investment cost. A positive NPV indicates that the project is expected to generate more cash inflows than outflows and is therefore considered a favorable investment.
- Internal Rate of Return (IRR): The IRR is the discount rate at which the NPV of an investment project becomes zero. It represents the project's expected rate of return and is compared to the company's required rate of return to assess its viability.
- Payback Period: This technique calculates the time required for the investment project to recover its initial cost. Projects with shorter payback periods are considered more favorable.
- Profitability Index: The profitability index compares the present value of cash inflows to the initial investment. A profitability index greater than 1 indicates that the project is expected to generate positive returns.
- Accounting Rate of Return (ARR): The ARR calculates the average annual accounting profit generated by an investment project as a percentage of the initial investment cost. It provides an indication of the project's profitability.
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