29-05-2012, 12:55 PM
CAPITAL BUDGETING DECISIONS
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CAPITAL BUDGETING DECISIONS
The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions.
The firm’s investment decisions would generally include expansion, acquisition, modernisation and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.
Decisions like the change in the methods of sales distribution, or an advertisement campaign or a research and development programme have long-term implications for the firm’s expenditures and benefits, and therefore, they should also be evaluated as investment decisions.
TYPES OF INVESTMENT DECISIONS
One classification is as follows:
Expansion of existing business
Expansion of new business
Replacement and modernisation
Yet another useful way to classify investments is as follows:
Mutually exclusive investments
Independent investments
Contingent investments
CAPITAL BUDGETING DECISIONS
These are generally:
Long-term decisions; involving large expenditures.
Have long term consequences.
Difficult or expensive to reverse.
DISADVANTAGES OF NPV METHOD
It is difficult to estimate the expected cash flows from a project.
Discount rate to be used is very difficult to determine.
Since this method does not consider the life of the projects, in case of mutually exclusive projects with different life, the NPV rule, tends to be biased in favour of the longer term project.
Since NPV is expressed in absolute terms rather than relative terms it does not consider the scale of investment.