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Paper Topic:

Capital budgeting


Before engaging in any kind of business activity , a businessman would want to know beforehand where his resources would go , the expected benefits he may derive therefrom and the number of years these benefits would be realized . When already engaged in business , he may have to make decisions involving additional requirements for long-term funds such as whether to acquire additional units of plant , property and equipment , to replace a machine , and to buy or lease fixed assets . All these problems require the use of capital budgeting tools and techniques p


Capital Budgeting is defined as the process of planning and controlling long-term investments . It involves evaluation of capital investment proposals , allocation of capital investment funds among approved projects and programs , and control of such expenditures . The planning and control measures which identifies and interrelates the essential requirements for an effective capital expenditure program consist of the following steps : 1 ) Proposal generation - Management encourages all levels within an organization to make suggestions for capital expenditures . Minor proposals are often reviewed at the next organizational level while major ones go to higher levels . 2 ) Gathering of relevant data on proposals submitted - This is undertaken for proposals where additional data are needed before they can be objectively evaluated . 3 ) Evaluation - Capital expenditure proposals especially the major ones are reviewed to determine whether they are appropriate or not and the economic benefits that may be derived therefrom . Cost- benefit analysis is applied by comparing the different cashflows involved . 4 ) Approval and implementation - Approval for capital expenditures is done at different levels depending on the materiality thereof . In some organizations , managers are given full authority to decide on expenditures required for continuous operations After being approved and funding has been made available , capital expenditures are made and the projects so approved are made operational 5 ) Control of expenditures and follow-up - Actual costs are recorded reported and compared with budgeted figures so that in case there are deviations , prompt corrective measures can be adopted . Remedial measures may be cost-cutting , improvement of benefits and even termination of the project

In evaluating capital investment proposals , two methods can be use First is the method that do not consider the time value of money which includes payback period , payback reciprocal , accounting rate of return average rate of return , and the payback bailout period . The payback period refers to the length of period or number of years it would take to recover an investment (Formula : Investment /Annual Cash Returns . The payback reciprocal indicates the percentage of investment that is expected to be recovered in one year ( Formula : Annual cash returns Investment or : 1 /payback period . This ratio indicates the rate of return on a venture project when the economic life of the investment is more than double the payback period . The accounting rate of return indicates the amount of net income realized per peso of investment (Formula : Net Income /Investment . The average rate of return shows the amount of net income per peso of average investment...

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