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CAPITAL BUDGETING
Capital budgeting is a decision situation where large funds
are committed (invested) in the initial stages of the project
and the returns are expected over a long period of time.
These decisions are related to allocation of investible funds
to different long-term assets.
Capital budgeting is a continuous process and it is carried
out by different functional areas of management such as
production, marketing, engineering, financial management
etc.
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BASIC FEATURES OF CAPITAL
BUDGETING
Capital
budgeting decisions have
long-term
implications.
These decisions involve substantial commitment of
funds.
These decisions are irreversible and require analysis
of minute details.
These decisions determine and affect the future
growth of the firm.
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CAPITAL BUDGETING DECISION INVOLVES
THREE STEPS:
o Estimation of costs and benefits of a proposal or of
each alternative.
o Estimation of the required rate of return, i.e., the cost
of capital
o Selection and applying the decision criterion.
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Capital-Budgeting Process
• The process is designed to help policy makers:
– In the selection of a few capital projects from many
alternatives
• From an inventory of capital projects to a capital budget
– In the timing of the expenditure to be incurred by the
projects selected
– In fitting the selected capital projects into the overall
financial program of the government unit
• (1) Capital asset inventory (2) capital
improvement plan (3) long-term financial analysis
(4) capital budget
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(1) Capital Asset Inventory
• An inventory and assessment of the existing capital facilities
includes its:
– Age
– Condition
– Degree of use
– Capacity / LOS
– Replacement cost
• The inventory of capital facilities helps to determine whether
the existing facilities are to be:
– Renewed, replaced, expanded, or retired
• It also helps to determine repair and maintenance needs and
estimated costs
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1. ESTIMATION OF CASH FLOWS
The costs and benefits for a capital budgeting
decision situation are