Published on Feb 16, 2016
The term Capital Budgeting refers to long term planning for proposed capital outlay and their financial. It includes raising long-term funds and their utilization. It may be defined as a firm's formal process of acquisition and investment of capital .
Capital budgeting may also be defined as "The decision making process by which a firm evaluates the purchase of major fixed assets". It involves firm's decision to invest its current funds for addition, disposition, modification and replacement of fixed assets. It deals exclusively with investment proposals, which is essentially long-term projects and is concerned with the allocation of firm's scarce financial resources among the available market opportunities.
Some of the examples of Capital Expenditure are
• Cost of acquisition of permanent assets as land and buildings.
• Cost of addition, expansion, improvement or alteration in the fixed assets.
• R&D project cost, etc.,
Capital budgeting is concerned with 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 immediate and subsequent streams of expenditure for it". In any growing concern, capital budgeting is more or less a continuous process and it is carried out by different functional areas of management such as production, marketing, engineering, financial management etc. all the relevant functional departments play a crucial role in the capital budgeting decision are considered.
The role of a finance manager in the capital budgeting basically lies in the process of critically and in-depth analysis and evaluation of various alternative proposals, and then to select one out of them. As already stated, the basic objectives of financial management is to maximize the wealth of the share holders, therefore the objectives of capital budgeting is to select those long term investment projects that are expected to make maximum contribution to the wealth of the shareholders in the long run. Objective of the Project
• To study the relevance of capital budgeting in evaluating the project in a government organization.
• To study the technique of capital budgeting for decision- making.
• To understand an item wise study of the organization financial performance.
• The data is collected through the observation in the organization and interview with officials.
By asking question with the accounts and other persons in the financial department.(oral questioning) These secondary data is existing data which is already been collected by Others, for that the sources are financial journals, annual reports of the SOUTH CENTRAL RAILWAY , RAILWAY website, and other Publications of RAILWAY
• The Project study is undertaken to analyze and understand the Capital Budgeting process in South Central Railway, which gives main exposure to practical implication of theory knowledge.
• To know about the organization's operation of using various Capital budgeting techniques.
• To know how the organization gets funds from various resources.
Features of Capital Budgeting
The important features, which distinguish capital budgeting decision in other day-to day decision, are Capital budgeting decision involves the exchange of current funds for the benefit to be achieved in future. The future benefits are expected and are to be realized over a series of years. The funds are invested in non-flexible long-term funds. They have a long term and significant effect on the profitability of the concern. They involve huge funds. They are irreversible decisions. They are strategic decision associated with high degree of risk.
The importance of capital budgeting can be understood from the fact that an unsound investment decision may prove to be fatal to the very existence of the organization.
The importance of capital budgeting arises mainly due to the following:
1. Large investment:
Capital budgeting decision, generally involves large investment of funds. But the funds available with the firm are scarce and the demand for funds for exceeds resources. Hence, it is very important for a firm to plan and control its capital expenditure.
2 . Long term commitment of funds:
Capital expenditure involves not only large amount of funds but also funds for long-term or an permanent basis. The long-term commitment of funds increases the financial risk involved in the investment decision.
3. Irreversible nature:
The capital expenditure decisions are of irreversible nature. Once, the decision for acquiring a permanent asset is taken, it becomes very difficult to impose of these assets without incurring heavy losses.
4. Long term effect on profitability:
Capital budgeting decision has a long term and significant effect on the profitability of a concern. Not only the present earnings of the firm are affected by the investment in capital assets but also the future growth and profitability of the firm depends up to the investment decision taken today. Capital budgeting decision has utmost has importance to avoid over or under investment in fixed assets.
5. Difference of investment decision:
The long-term investment decision are difficult to be taken because uncertainties of future and higher degree of risk.
6. Notional Importance:
Investment decision though taken by individual concern is of national importance because it determines employment, economic activities and economic growth.
Independent Project Decision
This is a fundamental decision in Capital Budgeting. It also called as accept /reject criterion. If the project is accepted, the firm invests in it. In general all these proposals, which yield a rate of return greater than a certain required rate of return on cost of capital, are accepted and the rest are rejected. By applying this criterion all independent projects with one in such a way that the acceptance of one precludes the possibility of acceptance of another. Under the accept-reject decision all independent projects that satisfy the minimum investment criterion should be implemented.
Mutually Exclusive Projects Decision
Mutually Exclusive project are those, which compete with other projects in such a way that the acceptance of one will exclude the acceptance of the other projects. The alternatively are mutually exclusive and only one may be chosen. Suppose a company is intending to buy anew machine. There are three competing brands, each with a different initial investment adopting costs. The three machines represent mutually exclusive alternatives as only one of these can be selected. It may be noted here that the mutually exclusive projects decisions are not independent of the accept-reject decisions.
Capital Budgeting Process
Capital budgeting is complex process as it involves decision relating to the Investment of current funds for the benefit for the benefit to be achieved in future and the future are always uncertain. However, the following procedure may be adopted in the process of Capital Budgeting.
Identification of investment proposals
The capital budgeting process begins with the identification of investment Proposals. The proposal about potential investment opportunities may originate either from top management or from any officer of the organization. The departmental head analysis various proposals in the light of the corporate strategies and submits the suitable proposals to the capital expenditure planning.
The expenditure planning committee screens the various proposals received from different departments. The committee reviews these proposals from various angles to ensure that these are in accordance with the corporate strategies, or selection criterion of the firm and also do not lead departmental imbalances.
Evaluation of Various proposals:
The next step in the capital budgeting process is to various proposals. The method, which may be used for this purpose such as, pay back period method, rate of return method, N.P.V and I.R.R etc.
After evaluating various proposals, the unprofitable uneconomical proposal may be rejected and it may not be possible for the firm to invest immediately in all the acceptable proposals due to limitation of funds. Therefore, it essential to rank the project/proposals after considering urgency, risk and profitability involved in there.