Factors to Be Considered in Capital Budgeting Decisions

FACTORS TO BE CONSIDERED IN CAPITAL BUDGETING DECISIONS

Capital budgeting is budgeting  is the process of planning and controlling investments for longterm projects and programs. The costs that are considered in capital budgeting analysis include: 1.

 Avoidable  Avoidable cost  cost  – cost that may be eliminated by ceasing an activity or by  improving efficiency. 2. Common cost – cost  – cost that is shared by all options and is not clearly allocable to any one of them. 3.  Weighted-average  Weighted-average cost of capital – capital – is the weighted average of the interest cost of debt (net of tax tax)) and the implicit cost of e!ity capital to be invested in longterm assets. "t represents a re!ired minim!m ret!rn of a new investment investment to  to prevent dil!tion of owners# interest. $. Deferrable or Postponable Postponable cost – cost  – cost that may be shifted to the f!t!re with little or not effect on c!rrent operation. %. Fixed cost – cost – cost that does not vary with the level of activity within the relevant range. &. mputed mputed cost – cost cost that that does does not entail entail a speci specifie fied d peso peso o!tla o!tlay y formal formally  ly  recogni'ed by the acco!nting acco!nting system b!t its nevertheless relevant to establishing the economic reality analy'ed in the decision-maing process. *. ncremental ncremental cost – cost – is the difference in cost res!lting from selecting one option instead of another. +. !ppor !pportun tunit ity y cost cost – is the benefit forgone by not selecting the  best alternative !se alternative  !se of scarce reso!rces. ,. "elevant cost – cost – f!t!re differential cost that vary with the action. 1. #un$ cost – cost – cost that cannot be avoided beca!se expendit!re or an irrevocable decision to inc!r the cost has been made. 11. Taxes – Taxes – tax conse!ences conse!ences of an investment investment.. FACTORS AFFECTING CAPITAL BUDGETING:

 Availability of Funds

Working Capital

Structure of Capital

Capital Return

Management decisions

Need of the project

 Accounting methods

overnment policy

!a"ation policy

#arnings

$ending terms of financial institutions

#conomic value of the project