The investment of funds in long term activities which

Info icon This preview shows pages 221–223. Sign up to view the full content.

View Full Document Right Arrow Icon
The Investment of Funds in long term activities which are usually non- flexible. Each project involves huge amount of funds Objective : 1. To find out the profitable capital expenditure. 2. Ensure efficient control over large investment and expenditures. 3. To find out the quantum of finance required for to capital expenditure. 4. To facilitate long range planning. 5. To evaluate the merits of each proposal to decide which project is best. 17.3.3 NEED AND IMPORTANCE OF CAPITAL BUDGETING Capital budgeting is the process of evaluating and selecting long-term investments that are consistent with the goal of the firm. There are many factors responsible for determining the need for capital investment like Expansion, Diversification, Obsolescence, Wear and tear of old equipment, Productivity improvement, Replacement and modernization and so on. When the investments are profitable the firm’s value will increase and they add to the shareholders’ wealth. The investment will add to the shareholders’ wealth if it yields benefits, in excess of the minimum benefits as per the opportunity cost of capital. The need and importance of capital budgeting has been explained as follows: 1. Long-term Implication Capital expenditure decision affects the company's future cost structure over a long time span. The investment in fixed assets increases the fixed cost of the firm
Image of page 221

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
215 which must be recovered from the benefit of the same project. If the investment turns out to be unsuccessful in future or give less profit than expected, the company will have to bear the extra burden of fixed cost. Such risk can be minimized through the systematic analysis of projects which is the integral part of investment decision. 2. Irreversible Decision Capital investment decision are not easily reversible without much financial loss to the firm because there may be no market for second-hand plant and equipment and their conversion to other uses may not be financially viable. Hence, capital investment decisions are to be carried out and performed carefully and effectively in order to save the company from such financial loss. The investment decision which is undertaken carefully and effectively can save the firm from huge financial loss aroused due to the selection of unfavorable projects. 3. Long-term Commitments of Funds Capital budgeting decision involves the funds for the long-term. So, it is long- term investment decision. The long-term commitment of funds leads to the financial risk. Hence, careful and effective planning is must to reduce the financial risk as much as possible. The significance of capital budgeting can also analyzed with the help of following points. Capital budgeting involves capital rationing. This is the available funds that have to be allocated to competing projects in order of project potential.
Image of page 222
Image of page 223
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern