Capital Budgeting: Process, Decisions, and Methods

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Capital Budgeting
It is defined as the process used by the business organizations for determining as well
as evaluating the potential large expenses or the investments. These investments and
expenditures includes the projects such as investments in the long-term ventures or building
of the new plant. Most often, the company assesses the perspective of the lifetime cash
inflows as well as outflows of the project for determining whether the generated potential
returns helps in meeting the target benchmark that are also referred as investment appraisal.
Hence, it is the formal process of the company that are used for the evaluation of investments
or the potential expenditures that are significant amount (Bierman & Smidt, 2014). It
generally involves decisions for investing the current funds for the addition, disposition as
well as replacement or the modification of the fixed assets such as new equipment, land and
buildings, rebuilding or replacement of the current equipment, development or research and
so on. The major amount that are spent for these projects is refereed as the capital
expenditures. It is the tool for the maximization of the future profits of the company, it is
because there are most of the companies that are able for managing only the limited number
of the major projects at time (Andor, Mohanty & Toth, 2015).
Capital budgeting generally involves the calculations of every future project
accounting profit by the period, the present value of the cash flows after considerations of the
time value of the money, cash flows by the period, the total number of the years it is taking
for the cash flow of the project for paying back initial cash investment, assessing the risk as
well as the different other factors (Chittenden & Derregia, 2015). There are several features
of the capital budgeting some of which are as follows:
 It generally involves high level of risk.
 The large amount of profits are estimated by the capital budgeting.

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 There is long time-period that exist between the initial investments as well as the
returns estimated.
Process of Capital Budgeting
Capital budgeting involves following the below steps:
 Identification of Project and Generation: It is the initial step of the capital
budgeting process for generating the proposal of the investments. Investment in the
business is done due to various reasons that may include expansion of the existing
product line or addition of the new product line. The proposal may be for increasing
the production or reducing the cost of the output (Daunfeldt & Hartwig, 2014).
 Screening of Product and Evaluation: This is the second step that requires selection
of the criteria that are correct for judging desirability of the proposal, which has to be
matched with the firm’s objective for maximizing their market value. Under this step,
the tool of time value of money are being used. Moreover, this step requires for the
estimation of the costs as well as the benefits. Further, the total of the cash inflow as
well as the cash outflow with the association of risks and uncertainties with that of the
proposal has to be thoroughly analyzed as for this to be done, there should be
appropriate provisioning of it (Hassan et al. 2015).
 Selection of Project: For the selection of the project there is no any defined method
for the investments as every organization has their different requirement. Therefore,
for approving the proposal of investment, the criteria of selection as well as process of
the selection should be defined by every organization by keeping in mind the
investment objectives. After the finalization of the proposal, there is exploration of
various alternatives for raising as well as acquiring of the funds by the team of
finance. The reduction of the average costs of funds has to be done. In the initial stage

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itself the detailed procedure of the periodical reports as well as tackling of the project
for lifetime has to be streamlined. Moreover, the final approval of the project are
based on the market conditions, viability, economic constituents as well as the
profitability (Malenko, 2018).
 Implementation: After the proposal is selected, the next step is to implement the
proposal. It includes different responsibilities such as implementation of the proposals
and completion of the project that too within the given time-period as well as
reduction of costs that are allocated.
 Review of Performance: It is the last stage of the capital budgeting as it involves
comparing the standard results with that of the actual results. The results that are
unfavorable are identified and the different difficulties that are related with the
projects are then removed for the selection as well as execution of the future proposals
(Nurullah & Kengatharan, 2015).