CA Inter FM, Investment Decision or Capital Budgeting | CA Intermediate Financial Management ,FM CA

CA Inter FM, Investment Decision or Capital Budgeting | CA Intermediate Financial Management ,FM CA

CA Inter FM, Investment Decision or Capital Budgeting | CA Intermediate Financial Management ,FM CA

The capital budgeting decisions are important, crucial and critical business decisions due to following reasons:

(i)Substantial expenditure
(ii) Long time period:
(iii) Irreversibility
(iv) Complex decisions:

(i) Substantial expenditure: Investment decisions are related with fulfillment of long term objectives and existence of an organization. To invest in a project or projects, a substantial capital investment is required. Based on size of capital and timing of cash flows, sources of finance are selected. Due to huge capital investments and associated costs, it is therefore necessary for an entity to make such decisions after a thorough study and planning.

(ii) Long time period: The capital budgeting decision has its effect over a long period of time. These decisions not only affect the future benefits and costs of the firm but also influence the rate and direction of growth of the firm.
(iii) Irreversibility: Most of the investment decisions are irreversible. Once the decision implemented it is very difficult and reasonably and economically not possible to reverse the decision. The reason may be up front payment of amount, contractual obligations, technological impossibilities etc.

(i) Mutually exclusive decisions: The decisions are said to be mutually exclusive if two or more alternative proposals are such that the acceptance of one proposal will exclude the acceptance of the other alternative proposals. For instance, a firm may be considering proposal to install a semi-automatic or highly automatic machine. If the firm installs a semi-automatic machine it excludes the acceptance of proposal to install highly automatic machine.

(iv) Complex decisions: The capital investment decision involves an assessment of future events, which in fact is difficult to predict. Further it is quite difficult to estimate in quantitative terms all the benefits or the costs relating to a particular investment decision.
The capital budgeting decisions on the basis of decision situation are classified as follows:
(i) Mutually exclusive decisions
(ii) Accept-reject decisions
(iii) Contingent decisions

Investment Decision or Capital Budgeting,

(ii) Accept-reject decisions: The accept-reject decisions occur when proposals are independent and do not compete with each other. The firm may accept or reject a proposal on the basis of a minimum return on the required investment. All those proposals which give a higher return than certain desired rate of return are accepted and the rest are rejected.
(iii) Contingent decisions: The contingent decisions are dependable proposals. The investment in one proposal requires investment in one or more other proposals. For example, if a company accepts a proposal to set up a factory in remote area it may have to invest in infrastructure also e.g. building of roads, houses for employees etc.
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