A number of project are often available to a business to invest in but each product has to be evaluated carefully. Depending upon the returns a particular project is either selected or rejected if there is only one project it really is the term of the rate of returns investment and its capital ability with the industries average is seen there are certain factors which affect capital budgeting decision.
- The cash flow of the project: when a company takes and investment decisions involving huge amount it expects to generate some cash flow over a period this cash flow are in the form of series of cash receipts and payments over the life of an investment the amount of these cash flows should be carefully analysed before considering a capital budgeting decision.
- The rate of return: the most important criterion is the rate of return of the project these calculations are based on the expected returns from each proposal and assessment of the risk involved suppose there are two projects A and b with the same risk involved with the rate of return of 10% and 12% respectively then under normal circumstances project bi should be selected.
- The investment criteria involved: the decision to invest in a particular project involves in a number of calculations regarding the amount of investment interest rate cash flow rate of return there are different techniques to invalid weight investment proposals which are known as capital budgeting decision and technique this technique is applied to each proposal before selecting a particular project.
Some features of capital budgeting
- Huge Funds: Capital budgeting involves expenditures of high value which makes it a crucial function for the management.
- High Degree of Risk: To take decisions which involve huge financial burden can be risky for the company.
- Affects Future Competitive Strengths: The company’s future is based on such capital expenditure decisions. Sensible investing can improve its competitiveness, whereas a wrong investment may lead to business failure.
- Difficult Decision: When the future is dependant on capital budgeting decisions, it becomes difficult for the management to grab the most appropriate investment opportunity.
- Estimation of Large Profits: Any investment decision taken by the company is made with the perspective of earning desirable profits in the long term.
- Long Term Effect: The effect of the decisions taken today, whether favourable or unfavourable, will be visible in the future or the long term.