Difficulties Faced In Capital Budgeting

This sample paper on Difficulties Faced In Capital Budgeting offers a framework of relevant facts based on recent research in the field. Read the introductory part, body, and conclusion of the paper below.

There are several factors and considerations which make the capital budgeting determinations as the most of import determination of finance director. The relevancy and significance of capital budgeting may be stated as follows:

Long term consequence: Possibly, the most characteristics of a capital budgeting determinations and which makes the capital budgeting so important is that these determinations have a long footings effects on the hazard and return composing of the house.

These determination affect the future place of the house to a considerable extent as the capital budgeting determinations have a long term deductions and effects. By taking a capital budgeting determination, a finance director in fact makes a committedness into the hereafter, both by perpetrating to the hereafter needs of financess of the undertakings and by perpetrating to its future deductions.

The masking characteristic between short term determinations and capital budgeting determinations is the clip.

Term Paper On Capital Budgeting

Significant Committedness: the capital budgeting determinations by and large involve big committedness of financess and as a consequence significant part of capital financess are block in the capital budgeting determinations. More attending is required for capital is required for capital budgeting determination. In footings hence, more attending is required for capital budgeting determinations, otherwise the house may endure from the heavy capital losingss in clip to come.

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It is besides possible that the return from a undertakings may non be sufficient plenty to warrant the capital budgeting determination.

Irreversible determinations: most of the capital budgeting determinations are irreversible determinations. Once taken, the house may non be in a place to return back unless it is ready to absorb heavy losingss which may ensue due to abandoning a undertaking in midway. Therefore, the capital budgeting determinations should be taken merely after sing and measuring each minute item of the undertaking, otherwise the fiscal effects may be far making.

Affect the capacity and strength to vie: the capital budgeting determinations affect the capacity and strength of a house to confront the competition. A house may lose fight if the determination to overhaul is delayed or non justly taken. Similarly, a timely determination to take over a minor rival may finally ensue even in the monopolistic place of the house.

Problems and Troubles in Capital Budgeting

The job in capital budgeting determinations may be as follows:

Future uncertainness: all capital budgeting determinations involve long term which is unsure. Even if every attention is taken and the undertaking is evaluated every minute item, still 100 % correct and certain prognosis is non possible. The finance director covering with the capital budgeting determinations, hence, should seek to be every bit analytical as possible. The uncertainness of the capital budgeting determinations may be mention to cost of the undertaking, hereafter, legal commissariats, political state of affairs etc.

Time Component: The deductions of a capital budgeting determination are scattered over a long period, the cost and benefit of a determination may happen at different point of clip. as a consequence, the cost and benefits of a capital budgeting determination are by and large non comparable unless adjusted for the clip value of money. The cost of a undertaking is incurred instantly ; nevertheless, it is recovered in figure of old ages. These entire returns may be more than the cost incurred, still the net benefit can non be ascertained unless the hereafter benefits are adjusted to do them comparable with the cost. Furthermore, the longer the clip period involved, the greater would be the uncertainness.

Measurement Problem: sometimes a finance director may besides confront troubles in mensurating the cost and benefits of undertakings in quantitate footings. For illustration: the new merchandise produced to be launched by a house may ensue in addition or lessening due to other factor besides.

Types Of Capital Budgeting Decisions

The undertaking may besides be classified as gross bring forthing undertakings or cost reducing undertakings. In general, the undertakings can be categorized as follows:

From the point position of firmaa‚¬a„?s being: the capital budgeting determinations may be taken by a freshly incorporated house or by an already existing house.

New Firm: A new integrated house may be required to take different determinations such as choice of a works to be installed, capacity use at initial phases, to put up or non at the same time the accessory unit etc.

Existing Firm: A house which is already bing may besides be required to take assorted determinations from clip to clip to run into the challenges of competition or altering environment.

From the point of position of determination state of affairs: The capital budgeting determinations may besides be classified from the point of position of the determination state of affairs as follows:

Mutually Exclusive Decisions: Two or more alternate proposals are said to be reciprocally sole when credence of one alternate consequence in automatic rejection of all other proposals. The reciprocally sole determinations occur when a house has more than one alternate but competitory proposal before it. For illustration, choosing one hardship bureau to take attention of the promotional run out justly rejects all other competitory bureaus. Similarly, choice of one location out of different executable locations is a reciprocally sole determination.

Accept-Reject Decisions: An Accept-Reject determination occurs when a proposal is independently accepted or rejected without respect to any other alternate proposal. This type of determination is made when proposal is cost and benefits neither consequence nor are affected by the cost and benefits of other proposals.

Contingent Decisions: sometimes, a capital budgeting determination is contingent to some other determination. For illustration, cybernation of a bank subdivision may necessitate non merely air-conditioning but besides transportation of some staff member to other subdivisions. Similarly, put ining a undertaking at some distant location may necessitate outgo or development of substructure besides.

Solution

CALUCATION OF CASH FLOWS

Particulars

Sum

Net income before revenue enhancement and depreciation ( PBT )

— – Depreciation ( w.note )

2,00,000

— -1,53,343

Net income before revenue enhancement

— – Tax @ 50 %

46,657

— – 23,329

Net income after revenue enhancement ( PAT )

23,328

Cash influx ( each twelvemonth ) = Net income after revenue enhancement ( PAT ) + depreciation

= 23,328 + 1,53,343

= Rs.1,76,671

Terminal influx in the 7th twelvemonth = Rs.30,000 ( trash value )

Working NOTESaa‚¬ ” :

Calculation of depreciation

= Cost of works + installing cost aa‚¬ ” bit value

Economic life

= 11,00,000 + 3,400 aa‚¬ ” 30,000

7yrs

= Rs.1,53,343

CALCULATION OF NET PRESENT VALUE

Year

hard currency influx

PVF ( 10 % , N )

Entire PVF ( Rs. )

1

1,76,671

0.909

1,60,594

2

1,76,671

0.826

1,45,931

3

1,76,671

0.751

1,32,680

4

1,76,671

0.683

1,20,667

5

1,76,671

0.621

1,09,713

6

1,76,671

0.564

99,643

7

1,76,671+30,000 =2,06,671

0.513

1,06,022

Sum of influxs 8,75,250

Less: hard currency escape ( at clip 0 ) -11,03,340

( Plant cost +installation charges )

NPV ( 2,27,975 )

NPV = PRESENT VALUE OF CASH INFLOW — PRESENT VALUE OF CASH OUTFLOW

Decision

Since the NPV of the proposal is negative, the proposal needs to be rejected.