The importance of capital budgeting cannot be exaggerated. Some of the reasons for this importance are mentioned below:
• Capital budgeting involves a greater amount of risk on account of unforeseen situations. Capital is generally invested with the expectation of future benefits which are likely to accrue over a long period of time. Therefore, a right decision has to be taken to ensure a favorable impact on the profitability and competitive position of the firm.
• Capital budgeting decisions are not easily reversible within a short period. Therefore, if a wrong decision is taken, it can lead to a heavy capital loss. In other words, if the firm allows the project to be completed, it will have to pay the penalty for a wrong decision for a longer period of time. But in case of areas like inventory control and credit control, even if an adopted policy is found to be wrong and undesirable, the same can be rectified within a short period. If a firm takes a number of wrong decisions, it would have a damaging impact on the viability of the firm. So, investment proposals should be properly taken.
• Investment decisions usually involve large amounts that remain blocked throughout the lifetime of the project. Apart from the long term capital investment, the necessary working capital support must also be ensured. In most of the cases, the supply of capital is not in abundance and, therefore, restraint has to be exercised in selecting investment proposals. It should be emphasized that whatever may be the source, it is not cost free. Therefore, during the selection of the investment proposals, the risks in terms of the supply of capital should be reduced as far as possible. This implies ensuring a regular return from the project, which should be reduced as far as possible. This implies ensuring a regular return from the project, which should be equal to or higher than its cost and, secondly, the recovery of capital invested during the lifetime of the project.
The Essay on Capital budgeting and investment decisions
According to Attrill and Mclaney, 2009, there are four (4) approaches to capital budgeting. The net present value (NPV) is one of such and is a summation of all discounted cash flows(Present Value) associated with whichever project(s) are undergoing appraisal. Every appraisal method have decision rules, examples include the Payback Period(PBP) which stipulates the approval of projects that pays ...
• It influences the other two important financial decisions of the firm, viz., financing decisions and dividend decisions. While the selection of profitable investment opportunities justifies the financing decisions, the dividend decision is also guided, among other things, by the profitability of the firm. Since one is related to the other a right investment decision facilitates financing and dividend decisions of the firm.
References
http://classof1.com/homework-help/accounting-homework-help/
