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NOTES ON CAPITAL BUDGETING

Capital Budgeting: Capital budgeting is the process of making investment decision in long-term assets or courses of action. Capital expenditure incurred today is expected to bring its benefits over a period of time. 

These expenditures are related to the acquisition & improvement of fixes assets. Capital budgeting is the planning of expenditure and the benefit, which spread over a number of years. It is the process of deciding whether or not to invest in a particular project, as the investment possibilities may not be rewarding. The manager has to choose a project, which gives a rate of return, which is more than the cost of financing the project. For this the manager has to evaluate the worth of the projects in-terms of cost and benefits. The benefits are the expected cash inflows from the project, which are discounted against a standard, generally the cost of capital. 

Capital budgeting Techniques: 

The capital budgeting appraisal methods are techniques of evaluation of investment proposal will help the company to decide upon the desirability of an investment proposal depending upon their; relative income generating capacity and rank them in order of their desirability. These methods provide the company a set of norms on the basis of which either it has to accept or reject the investment proposal. The most widely accepted techniques used in estimating the cost-returns of investment projects can be grouped under two categories. 

1. Traditional methods 

2. Discounted Cash flow methods 

1. Traditional methods 

These methods are based on the principles to determine the desirability of an investment project on the basis of its useful life and expected returns. These methods depend upon the accounting information available from the books of accounts of the company. These will not take into account the concept of 'time value of money', which is a significant factor to determine the desirability of a project in terms of present value. 

A. Pay-back period method: It is the most popular and widely recognized traditional method of evaluating the investment proposals. It can be defined, as 'the number of years required to recover the original cash out lay invested in a project'. 

According to Weston & Brigham, "The pay back period is the number of years it takes the firm to recover its original investment by net returns before depreciation, but after taxes". 

According to James. C. Vanhorne, "The payback period is the number of years required to recover initial cash investment.