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Captial Budgeting-Introduction

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Capital budgeting is a process that involves making of investment decision by company from one or a series of investment projects to identify the most worthwhile projects for undertaking.
A company’s capital investment usually focuses:-
• Expansion in existing market
• Develop new products or entering new market
• Purchase new building / plants
• Replacement or improvement on existing equipment
Capital budgeting decision is vital for any company because it always involved:
• Large investment – capital budgeting decision usually involve large investment of funds but mostly there is a shortage of funds at every firm. Hence the funds and the resources need to be controlled by the firm
• Irreversible nature- once the decision for acquiring a permanent assets is taken, it becomes very difficult to dispose of these assets with the incurring heavy cost
• Long term effect on profitability- Not only the present earning of the firm is affected but the future growth and profitability also depend upon investment decision taken today, any unsound decision made can lead to a downfall tomorrow

Capital budgeting is a complex process as it involved decision relating to the investment of current funds for the benefit to be achieved in the future but future is always uncertain. The 5 step process in capital budgeting decision is:

I. Identified investment opportunities- investment proposal or projects normally was initiated by a firm’s management or staffs in line with the corporate objective e.g. maximise market shares, developing new markets, etc
II. Analyse & consider alternative- management are required to screen & select alternatives to be taken out of numbers of projects proposed within the firm
III. Analyse & project evaluation- projects pass through preliminary screening phase are subject to financial appraisal / project evaluation to ascertain if they are

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