Capital Budgeting

CAPITAL BUDGETING CAPITAL INVESTMENT – INVESTMENT – involves significant significant commitment commitment of funds to receive a satisfactory satisfactory return return – increase in revenue revenue or reduction in costs over an extended period of time. Example: purchase of equipment for expansion, replacement of old equipment. GENERAL CHARACTERISTICS OF CAPITAL INVESTMENT DECISIONS AS TO COST usually involves large expenditure of resources, relative to business size AS TO COMMITMENT usually funds invested are tied up for a long period of time AS TO FLEXIBILITY usually more difficult to reverse than short-term decisions AS TO RISK usually involves so much risks and uncertainties due to operational and economic changes over an extended period of time    

CAPITAL BUDGETING – BUDGETING – is the process by hich management identifies, evaluates, and makes decision on capital investment pro!ects of an organization. "t is the process of planning expenditures for assets, the return on hich are expected to continue beyond one-year period. CAPITAL INVESTMENT FACTORS Net Investments (f! "e#$s$n%m&'$n )*!)ses+ #osts less savings incidental to the acquisition of the capital investment pro!ects #ash outflos less cash inflos incidental to the acquisition of the capital investment pro!ects  

#osts or cash outflos $. %urchase %urchase price price of the the asset, asset, net net of related related cash cash discount discount &. "ncidenta "ncidentall pro!ect-relate pro!ect-related d expenses such as freight, freight, insurance, insurance, handling, handling, installati installation, on, test-runs, test-runs, etc. #'()"*E+ )' /E 0''1"(2, if any:  dditional orking capital capital needed to support the operation of the pro!ect pro!ect at the desired desired level. 3arket value of existing idle assets to be used in the operation of the proposed capital pro!ect. raining cost, net of related tax   

)avings or cash inflos $. %roceeds %roceeds from from sale sale of old asset asset disposed, disposed, net of of related related tax tax #'()"*E+ )' /E 0''1"(2, if any: rade-in value of old asset  voidable cost cost of immediate immediate repairs on the old asset asset to be replaced, replaced, net of related tax tax  

Net Ret*!ns  ##+4 5)"): 5)"): ccounting net income 6after tax7 tax7 #)/ 5)"): (et cash inflos  *"+E# 3E/'* 6#ash inflos – #ash outflos7  "(*"+E# 3E/'* 6(et income after tax 8 (oncash expenses7  

I,,*st!&t$n- Net Investments f! De#$s$n%M&'$n 5icol #ompany plans to replace a unit of equipment that as acquired three 697 years ago and is no recorded at a book value of %;,. *ata on these opportunities under consideration are given belo: %ro!ect $ & 9 ? ;

"nvestment %9;,