Capital Budget

9 Key excerpts on "Capital Budget"

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  eBook - ePub

  Capital Budgeting

  • Sandeep Goel(Author)
  • 2015(Publication Date)
  • Business Expert Press

    (Publisher)

  SECTION 2 Capital Budgeting Decision & Appraisal Passage contains an image CHAPTER 2 Capital Budgeting: Nature & Scope

  The Present Chapter

  It discusses the concept of Capital Budgeting, its process, techniques, and risk analysis of capital investment decisions by the business units.

  Introduction

  Capital Budgeting decision relates to decision of investment in long-term projects. Capital Budgeting is often used interchangeably with capital expenditure or capital investment. Any expenditure that generates a cash flow benefit for more than one year, it is a capital expenditure. For example, the purchase of new equipment, expansion of production capacity, buying another company, research & development, and so on. Capital Budgeting involves large cash outlays for generating future return of the company. Once, a Capital Budgeting decision is committed, it is often difficult to reverse. Therefore, we need to carefully analyze and evaluate proposed Capital Budgeting decisions.

  “Capital Budgeting is long-term planning for making and financing proposed capital outlays.” —Charles T. Horngnen “Capital Budgeting is concerned with the firm’s formal process for the acquisition and investment of capital.” —Hamption, John. J.

  In a capital investment decision, the major criterion for selection of a project is its viability and impact on shareholder value. The two most important parameters for arriving at a project decision are the project’s expected cash inflows and outflows. They determine whether the returns meet a sufficient target benchmark or not.

  Capital Budgeting Decision: An Overview

  The Capital Budgeting decision, as already pointed out, pertains to investment in fixed assets/long-term assets and the returns are expected over a long period of time. It is the process of identifying, analyzing, and selecting investment projects whose returns (cash flows) are expected to extend beyond one year.1

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  Essentials of Corporate Finance

  • Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  In the final analysis, Capital Budgeting is really about management’s search for the best capital projects—those that add the greatest value to the firm. Over the long term, the most Capital Budgeting the process of choosing the productive assets in which the firm will invest LEARNING OBJECTIVE 1 286 CHAPTER 9 I The Fundamentals of Capital Budgeting successful firms are those whose managements consistently search for and find capital invest- ment opportunities that increase firm value. The Capital Budgeting Process The Capital Budgeting process starts with a firm’s strategic plan, which spells out its strategy for the next three to five years. Division managers then convert the firm’s strategic objectives into business plans. These plans have a one- to two-year time horizon, provide a detailed description of what each division should accomplish during the period covered by the plan, and have quantifiable targets that each division is expected to achieve. Behind each division’s business plan is a Capital Budget that details the resources management believes it needs to get the job done. The Capital Budget is generally prepared jointly by the CFO’s staff and financial staffs at the divisional and lower levels and reflects, in large part, the activities outlined in the divisional business plans. Many of these proposed expenditures are routine in nature, such as the repair or purchase of new equipment at existing facilities. Less frequently, firms face broader strategic decisions, such as whether to launch a new product, build a new plant, enter a new market, or buy a business. Exhibit 9.1 identifies some reasons that firms initiate capital projects. EXHIBIT 9.1 Key Reasons for Making Capital Expenditures Capital Budgeting decisions are the most important investment decisions made by management. Many of these decisions are routine in nature, but from time to time, managers face broader strategic decisions that call for significant capital investments.

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  Fundamentals of Finance

  Investments, Corporate Finance, and Financial Institutions

  • Mustafa Akan, Arman Teksin Tevfik(Authors)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  10 The Basics of Capital Budgeting 10.1 Introduction We now focus on investment principle (Capital Budgeting). The Capital Budget must re-late to the firm ’ s mission and its abilities to meet competitive challenges. Information from marketing, finance, and production analyses are put together to form cash flow estimates of proposed projects. Project risk considerations enter the Capital Budget analysis because higher-risk projects should be expected to earn higher returns than lower-risk projects. The Capital Budget evaluation is done with the goal of identifying projects that will increase shareholder wealth. This chapter examines the process of evaluating projects and determining the inputs that are used to form the cash flow estimates. 10.2 Data and Stages in Capital Budgeting The Capital Budget must relate to the firm ’ s mission and its abilities to meet compet-itive challenges. Information from marketing, finance, and production analyses are put together to form cash flow estimates of proposed projects. Capital Budgeting is the process of identifying, evaluating, and implementing a firm ’ s investment opportunities. 1 Various methods of Capital Budgeting are avail-able. However, it is the continuous planning and feedback cycles of Capital Budget-ing that allow a company to grow and prosper. Capital Budgeting helps companies in the following areas: – better working capital, the capital used for day-to-day expenses – profit maximization due to proper budgeting of funds – an increase in firm value when cash flow benefits exceed capital expenditures – proper investment in assets that generate earning power and profitability Capital Budgeting decisions can involve mutually exclusive or independent projects. Mutually exclusive projects mean that selecting one project precludes others from being undertaken. Independent projects are not in direct competition with one another.

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  Capital Budgeting

  Theory and Practice

  • Pamela P. Peterson, Frank J. Fabozzi(Authors)
  • 2004(Publication Date)
  • Wiley

    (Publisher)

  Capital Budgeting is the process of identifying and selecting investments in long-lived assets, or assets expected to produce ben- efits over more than one year. In Section II, we discuss how to eval- uate cash flows in deciding whether or not to invest. We cover how to determine cash flow risk and factor this risk into Capital Budget- ing decisions in Section III. Capital BudgetING Because a firm must continually evaluate possible investments, capi- tal budgeting is an ongoing process. However, before a firm begins 6 The Investment Problem and Capital Budgeting thinking about Capital Budgeting, it must first determine its corpo- rate strategy — its broad set of objectives for future investment. For example, the Walt Disney Company’s objective is to “be the world’s premier family entertainment company through the ongoing devel- opment of its powerful brand and character franchises.” 1 Consider the corporate strategy of Mattel, Inc., manufacturer of toys such as Barbie and Disney toys. Mattel’s strategy is to become a full-line toy company and grow through expansion into the international toy market. In the early 1990’s, Mattel entered into the activity toy, games, and plush toy markets, and, through acquisi- tions in Mexico, France, and Japan, increased its presence in the international toy market. 2 How does a firm achieve its corporate strategy? By making investments in long-lived assets that will maximize owners’ wealth. Selecting these projects is what Capital Budgeting is all about. Stages in the Capital Budgeting Process There are five stages in the Capital Budgeting process. 1 The Walt Disney Company Annual Report 2000: 10. 2 Mattel, Inc., 1991 Annual Report: 4–5, 15. Stage 1: Investment screening and selection Projects consistent with the corporate strategy are identified by production, marketing, and research and development management of the firm.

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  Public Finance Administration

  • B. J. Reed, John W. Swain(Authors)
  • 1996(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  C H A P T E R Capital Budgeting C apital budgeting refers to the efforts by public agencies to develop a. financial plan of action directed at the funding of land, improvements, facilities, and equipment for use in the immediate, intermediate, and long-term future. According to Forrester, it is closely tied with many objectives of budgeting and financial management, including debt administration, assess-ing financial condition, and supporting economic development. 1 Budgeting for capital items is most often associated with longevity, high cost, and major impact. Items that have a useful life extending beyond a single year are considered to have longevity and are candidates for Capital Budgeting. Such items become fixed assets. Also, high-cost physical items that make a substan-tial impact on an annual budget if funded in any one year are candidates for Capital Budgeting. Finally, items expected to have a significant impact that are not easily changed are often included within a Capital Budget. Examples of capital items are all around us. Land, public buildings, large and expensive equipment, and public improvements, such as streets and sewers, are all items that should be included in a Capital Budget. Costly items with a short useful life and low-cost items with a long useful life are often excluded from Capital Budgets. Thomassen noted that in states, for example, human and intellectual capital, research and development, training and education, and loans are all excluded from the capital and budgeting process. 2 Personnel costs can be quite large but do not represent permanent or semipermanent fixed assets to the organization. Correspond-ingly, typewriters or personal computers are not consumed within the first year of purchase; however, their cost can be readily absorbed into the annual operating budget rather than added to the Capital Budget.

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  Public Finance N6 SB

  TVET FIRST

  • D O'Dougherty A Kruger(Author)
  • 2016(Publication Date)
  • Macmillan

    (Publisher)

  However, because the amount of capital available at any given time for new projects is limited, managers need to use Capital Budgeting techniques to decide which projects will yield the greatest cash flow. Why is Capital Budgeting important? Capital Budgeting is important because: • It usually involves large sums of money. This influences the profitability of organisations. • Organisations cannot reverse long-term expenditures without losing significant amounts of the capital they have spent on projects. Organisations must carry the losses, sometimes for many years. These expenditures will influence how organisations conduct themselves. Therefore, Capital Budgeting decisions define the strategic plans of organisations. • Long-term expenditure decisions are the basis on which organisations earn their profits. They measure their profits according to the cash inflows on the capital they have spent. Managers need to forecast cash inflows and profits for the lives of projects. • The implications of long-term expenditure decisions are more extensive than are those of short-term decisions because of the time factors involved. • Capital Budgeting decisions are subject to higher levels of risk and uncertainty than are short-term decisions. Unit 4.1: The concepts of Capital Budgets Did you know? Because financing expensive capital expenditure projects often involves borrowing money, the types of organisations that practise Capital Budgeting have different priorities: • Privately owned companies exist to make profits on the money they have borrowed. • State-owned enterprises (SoEs) exist to serve citizens through the services they offer. They want to show profits or break even (reach a point where expenses and revenue are equal). • Governments exist to serve the citizens. They want to reduce the amounts of interest they have to repay on the money they have borrowed to finance capital projects. They also want to reduce the length of time it will take them to repay the loans.

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  Canadian Public-Sector Financial Management

  Second Edition

  • Andrew Graham(Author)
  • 2014(Publication Date)
  • McGill-Queen's University Press

    (Publisher)

  Simply treating capital expenditures as current expenditures taken out of operating budgets distorts the true costs of the asset acquisition. Having capital projects dependent on year-to-year approvals restricts the capacity of the organization to commit to the full cost of the project. Approving an investment in the first phase of major construction, and then reviewing it entirely without approving the next phase, can lead to a series of complications ranging from waste of public funds to a reluctance to engage in the high-risk venture in the first place. Finally, it is often the case that capital projects involve long-term debt for the organization. The challenge of long-term financing involves a good understanding of the true costs of the investment, a process of analysis quite different from analyzing operating expenditures.

  A distinction that has already been drawn between operating and Capital Budgets is that of time. Operating budgets are generally appropriated and reported upon for a single fiscal year, although many governments are providing information on future years and some actually provide multi-year approvals. The Capital Budget, while it involves actual cash disbursements within the course of a fiscal year, more often involves a flow of cash over a number of years to create an asset with a life longer than one year. Both the investment flow and the asset return extend over a considerable period of time.

  In addition, as governments move more aggressively into accrual accounting and budgeting, they will be forced to treat capital differently. As an example, adequate budgeting for, and reporting of, capital depreciation will highlight capital costs as never before. So, too, will the reporting of the current costs of debt to finance capital. In the case of voluntary organizations, capital acquisitions are often linked to the organization’s debt planning and credit ratings and thus receive particular attention. Figure 7.5 : Budget of the City of Lethbridge provides a good example of a budget presentation that combines a summary of operating and capital expenditures. Behind that summary document, it has to be remembered, is a 400-page budget statement and a separate Capital Improvement Plan.1

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  Introduction to Corporate Finance

  • Laurence Booth, Ian Rakita(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  13-1 Capital Budgeting, Risk Considerations, and Other Special Issues Business investment plays a critical role in the productivity of the firm. In this chapter, we discuss long‐term investment decisions made by companies, particularly decisions about investments in real assets, such as property, plant, and equipment. In previous chapters, we have seen that a firm’s investment decisions are critical to firm value, because market values are based on the expected future growth in company earnings, dividends, and distributable cash flows. In this chapter, we will also revisit several concepts we discussed when describing how to value bonds and shares, and we will emphasize that the basic techniques are identical: we have to estimate future cash flows, determine appropriate discount rates, convert those expected future cash flows back into their corresponding present values, and compare them with their cost. The essential difference between valuing shares and valuing projects or companies is not in the approach but in the judgement necessary because of the differing “quality” of the inputs. 13.1 Describe the Capital Budgeting process and explain its importance to corporate strategy. 13.2 Identify and apply the main tools used to evaluate investments. 13.3 Analyze independent projects and explain how they differ from interdependent projects. 13.4 Explain what capital rationing is and how it affects firms’ investment criteria. 13.5 Explain the importance of international foreign direct investment both inside and outside Canada. 13.6 Explain how the modified internal rate of return (MIRR) is calculated and why this represents a conceptual improvement over the way the IRR is calculated. LEARNING OBJECTIVES After studying this chapter, you should be able to: CHAPTER 13 13.1 Capital Expenditures LEARNING OBJECTIVE 13.1 Describe the Capital Budgeting process and explain its importance to corporate strategy.

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  Handbook of Debt Management

  • Gerald J. Miller(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  Unlike the operational budget that may change overnight or from one fiscal year to the next, Capital Budgets convey a more permanent sense of priorities and direction. Although the funding of Capital Budgets is done through annual appropriations, many times its approval amounts to the passing of a multiyear budget. According to Axelrod (1988:277), governments use multiyear budgeting to change the direction of budget priorities, to help stabilize the priorities of programs and projects, to control expenditures, to discourage piecemeal decisions, and to lighten the budgetary workload. In addition to its possible contributions as a form of a multiyear budget, Capital Budgets can help program managers develop a better understanding of the opportunities and the constrains on future action. With the addition of a new office building or the introduction of a new information technology system to the CIP, a practicing manager could tell that the odds of seeing an affirmative action on a request to build another building or to purchase another system shortly after are low. From a strategic management point of view the important thing is that all managers at all levels and across the board are likely to get a similar message about the future of any such requests. At the same time it may encourage individual managers to search independently of each other for ways to exploit the new opportunities that result from such an improvement. Any success in this regard amounts to an improvement on the rate of return on the involved investment. Knowing that by the end of a given period the organization is going to have a new capacity in any respect may encourage managers to look for opportunities to take advantage of it, possibly by initiating new or different programs or work processes. Here, too, the logic of the garbage can model of decision making illustrates how possible solutions can start floating around in search of problems. These initiatives by managers may prevent inertia from settling in. This, in turn, can diminish the risk of overlooking an emerging threat, a likely event when inertia does settle in.

  Strategic management is designed to cut across departmental lines and functional areas in pursuit of the strategic plan. The development of a Capital Budget follows the same approach with results that are very different from the ones usually obtained from the regular budgeting process. It is only a slight exaggeration to suggest that it is only during the annual budget cycle that the individual departments of a local government, for example, are forced to acknowledge that they are indeed part of the same agency. The needs of central staff units such as finance, personnel, electronic data processing, and purchasing are not likely to be factored into the workplans of the individual operating departments. Managers develop workplans for their respective units without worrying about the budgetary implications for other line and staff units. Resolving such problems is assumed to be the domain of the budget department or the top manager. It is not uncommon for staff and line units to organize their individual operations on the basis of a narrow, provincial view of the public’s needs; this serves as an enormous centrifugal force in the local government organization.

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