Capital budgeting is the process of making

investment in capital expenditure (CAPEX).

A CAPEX may be defined as an expenditure
the benefit of which are expected to be
received over a period of time exceeding one
year.
The main characteristic of CAPEX are that an
expenditure is incurred at one point and
benefits are realized at different point of
time.
1. Cost of acquisition of permanent assets e.g.
building; plants & machineries etc.
2. Cost of replacement of old permanent
assets.
3. Research and development project costs.
It influences the firms growth path.
It affects the risk of the firm.
It involves large amount of funds of the firm.
It is unchangeable and can be reversed at
high cost.
It is the most difficult decision to make.
capital budgeting is long term planning for
making and financing proposed capital
outlays - Charles T. Horngren
Capital budgeting consists in planning
development of available capital for the
purpose of maximizing the long term
profitability of the concern.
Capital budgeting decisions involve the
exchange of current funds for the benefits to
be achieved in future.
The future benefits are expected to be
realized over a series of years.
The funds are invested in non-flexible and
long term activities.
They have long term and significant effects
on profitability of the concern.
They are irreversible decisions
There are three steps involved in the
evaluation of an investment.
1. Estimation of cash flows.
2. Estimation of the required rate of return.
3. Application of the decision rule for making
the choice.
It should consider all cash flows to determine
the true value of the project.
It should help in ranking the various projects
according to their true benefits.
It should help to choose among the mutually
exclusive projects.
It should be a criteria, which is applicable to
any conceivable investment project
independent of others.
Discounted cash flow criteria:
Net present value
Internal rate of return.
Profitability index.
Discounted pay back period.
Non-discounted cash flow criteria:
Payback period.
Accounting rate of return