Capital budgeting is a financial procedure to ensure that capital is allocated to value adding opportunities. A capital budgeting / investment proposal should be accepted /rejected depending on whether it generates, over the life of investment, returns more than its cost of capital.
Capital budgeting is concerned with the allocation of the firm's scarce financial resources among the available market opportunities. The consideration of investment opportunities involves the comparison of the expected future streams of earnings from a project, with the immediate and subsequent expenditures for it."
An analysis of the above definition shows that capital budgeting correlates the planning of available financial resources and their long term investment with a view to maximize the profitability of the firm. The financial manager has to focus on maximizing the wealth of shareholders through investment decisions. Investment decisions are long-term strategic decisions. Thus, he should be in apposition to evaluate whether a particular investment will facilitate achievement of this goal or not. It is also known as investment decision, capital expenditure, capital expenditure planning, project planning etc. it is a process of making decision regarding investments in fixed assets which are not meant for sale such as land, building, machinery or furniture capital budgeting is the planning of the expenditure for a future return. It returns stretch themselves beyond a one-year time interval. Capital expenditure planning and control is a process of facilitating decisions covering expenditures on long-term assets. Since a company survival and profitability hinges on capital expenditure, specially the major ones, the importance of the capital budgeting process cannot be over emphasized.
[...] The theory of measuring cost of capital is not simple. The company has a total sale of Rs Million, and total gross assets of Rs Mn. and net profit of Rs Mn. in 2007. The capital structure of the company is given by: The average market price of one share in 2007 was $ The market value of the company's equity is obtained by multiplying the number of the outstanding shares ( 92.7 crore) by the average share price. The market value of debt is assumed to be equal to the book value. [...]
[...] INTRODUCTION TO PROJECT INTRODUCTION The investment decisions of a firm are generally known as capital budgeting or capital expenditure decisions. Thus, a capital budgeting decision may be defined as: firm's decision to invest its current funds most efficiently in long term assets in anticipation of an expected flow of benefits over a series of years.” The firm's investment decision would generally include expansion, acquisition, modernization and replacement of long term assets. Sale of a division of business (divestment) is also an investment decision. [...]
[...] The top management then calls a meeting where these proposals are examined and the financial manager is asked to present several alternative capital expenditure budgets for the recommended for the recommended proposals. The top management then finally selects some of the important proposals. Once capital expenditure proposals have been finally selected, funds are allocated to them. Implementation Once a capital expenditure budget has been prepared and a proposal has been included in the budget, the next step is to requisite the authority to go ahead with the project. [...]
[...] ROIC equal to WACC may be a justifiable assumption for most stable industry. - ROIC could exceed WACC for businesses, which enjoy significant intangibles such as territorial advantages, brand loyalty and proprietary technology. Benchmarking g and ROIC with the Reinvestment Rate Reinvestment Rate is defined as g/ROIC. The Reinvestment rate can be sense- checked and benchmarked with existing industry players (for a mature industry) to obtain a better understanding of the and ROIC assumption. STEP RISK ANALYSIS Risk analysis is performed to understand the potential upside / downsides to value the potential of a project from its base case. [...]
[...] As far as the calculation of IRR is considered, it involves a tedious and complicated trial and error procedure. II. An important drawback of the IRR technique is that it makes an implied assumption that the future cash inflows of a proposal are reinvested at a rate equal to the IRR. III. Since, the IRR is a scaled measure, it tends to be biased towards the smaller projects which are much more likely to yield higher percentage returns over the larger projects. [...]
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