CAPITAL BUDGETING | AFM IMPORTANT TOPIC 2023
Here is what you need the most, notes on the most important topics and capital budgeting of the JAIIB AFM 2023 exam which will help you in revision.
Let’s discuss capital budgeting in detail, its features, how it works, techniques and methods along with suitable examples, processes involved, influencing factors, objectives, and limitations.
Businesses run on two key objectives that are expansion and growth. In order to realize these a company must possess a threshold amount of fixed assets and capital and to manage all this capital budgeting is important.
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WHAT IS CAPITAL BUDGETING
A business uses capital budgeting as a tool to assess potential big projects or investments. Examples of projects that might require capital budgeting before they are approved or denied include the construction of a new factory or a significant investment in an outside enterprise. It’s a tool used by the management to work out expenditures on fixed assets. The key objective of capital budgeting is to make a long-term investment decision about the project like whether it will lead to sustainable growth and expected returns.
The process by which a company decides which investments in projects or purchases of fixed assets are acceptable and which are not is known as capital budgeting. This method involves quantitatively analyzing each proposed investment, enabling the business owners to make informed decisions.
Since managing capital assets costs a lot of money, capital budgeting is necessary before such investments are made to make sure they will bring in profits for the business. The enterprises must take steps to increase their profitability and the wealth of their shareholders and investors.
There is the duration of the long period between the commenced investment and anticipated returns. The firm conventionally estimates large profits and this process is risky. It’s a kind of fixed investment for the long term and this determines the financial condition of the company. The profitability of a project is directly influenced by the amount invested in it.
| Watch the class on the method of capital budgeting at the given links
Part I: https://youtu.be/VMajeIfHGsA Part I: https://youtu.be/Qj4eMgNyrvQ |
CAPITAL BUDGETING PROCESS
Identification of investment proposal: Various proposals have to be analyzed in accordance with corporate strategies and then submit suitable proposals.
Evaluation of various proposals and Selecting proposals: The proposed offers are evaluated by different organizations and figured out they are suitable according to corporate strategies, are profitable and do not lead to departmental imbalances. The payback period method, rate of return method, net present value method, and internal rate of return method are used for the purpose of evaluation.
Fixing priorities: Limitation of funds, urgency, risk, and profitability are the factors which may influence the priority fixing of projects.
Implementing proposals: After the preparation of the capital budgeting, authorization is required which may further review the profitability in variable circumstances before the implementation.
Performance review: post-completion of the project performance is evaluated and involves a comparison of actual expenditure on the project with the budgeted one and the actual return with the expected return.
| Here is an explanatory video on the topic of sources of corporate finance.
Part I https://youtu.be/bjNCfKLY7xI Part II https://youtu.be/bjNCfKLY7xI |
IMPORTANCE OF CAPITAL BUDGET
Large investments: Due to their limited resources, all businesses must make sizable investments in order to grow. As a result, they must choose their investments carefully. The erroneous decision could have a substantial effect on the acquisition of an asset, the rebuilding or replacement of existing equipment, or even the sustainability of the business.
The long-term commitment of funds: It requires a considerable amount of capital outlay which further needs thoughtful decision-making.
Irreversible nature: Mostly the cases involved are reversible and stepping back may lead to a disastrous loss that’s why there is the ardent significance of capital budgeting.
The long-term effect on profitability and Difficulty of investment decisions: There is a likelihood that an organization’s profitability will increase if the expenditures were made after a budget had been properly prepared.
PRACTISE QUESTIONS
| …………….. are expenditures incurred by a company to acquire and upgrade assets of a company.
Revenue expenditures Capital expenditures Revenue receipts Capital receipts |
| Making investment decisions in long-term assets is known as
Capital expenditure Capital budgeting Investment budget None of the above |
| Which of the following statement is not true about capital budgeting
Capital budget decisions have an influence on the future stability of an organization Capital budget decisions include investments to expand the business Capital budgeting is of reversible nature None of the above |
| Which of these included in the capital budgeting decision
Expansion program Acquisition of long-term assets Replacement of an existing All of the above |
| Sunk cost is a relevant cost in capital budgeting. Is this statement true
Statement is true Statement is false |
For the verification of your answer and explanation watch: https://youtu.be/FDo8Bn8NR5A
COVER FOLLOWING TOPIC
COST OF CAPITAL: https://youtu.be/22BTgQY1R-s
SECURITY AND EXCHANGE BOARD OF INDIA: https://youtu.be/bKiZvEuBnsk
TIME VALUE OF MONEY: https://youtu.be/bZaJ4ricoIY
LEARNING SESSIONS STUDY MATERIAL
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