what is the relevance of capital budgeting techniques in the mgt decision function?

Answer 1

Capital budgeting refers to the process we use to make decisions concerning investments in the long-term assets of the firm. The general idea is that the capital, or long-term funds, raised by the firms are used to invest in assets that will enable the firm to generate revenues several years into the future. Often the funds raised to invest in such assets are not unrestricted, or infinitely available; thus management must make a decision on how these funds are invested.

Importance of Capital Budgeting—because capital budgeting decisions impact the firm for several years, they must be carefully planned. A bad decision can have a significant effect on the firm’s future operations. In addition, the timing of the decisions is important. Many capital budgeting projects take years to implement. If firms do not plan accordingly, they might find that the timing of the capital budgeting decision is too late, thus costly with respect to competition. Decisions that are made too early can also be problematic because capital budgeting projects generally are very large investments, thus early decisions might generate unnecessary costs for the firm.

Generating Ideas for Capital Budgeting—ideas for capital budgeting projects usually are generated by employees, customers, suppliers, and so forth, and are based on the needs and experiences of the firm and of these groups. For example, a sales representative might continue to hear from some of his or her customers that there is a need for products with particular characteristics that the firm’s existing products do not possess. The sales representative presents the idea to management, who in turn evaluates the viability of the idea by consulting with engineers, production personnel, and perhaps by conducting a feasibility study. After the idea is confirmed to be viable in the sense it is saleable to customers, the financial manager must conduct a capital budgeting analysis to ensure the project will be beneficial to the firm with respect to its value.

Project Classifications—capital budgeting projects usually are classified using the following terms:
" Replacement decision—a decision concerning whether an existing asset should replaced by a newer version of the same machine or even a different type of machine that does the same thing as the existing machine. Such replacements are generally made to maintain existing levels of operations, although profitability might change due to changes in expenses (that is, the new machine might be either more expensive or cheaper to operate than the existing machine).
" Expansion decision—a decision concerning whether the firm should increase operations by adding new products, additional machines, and so forth. Such decisions would expand operations.
" Independent project—the acceptance of an independent project does not affect the acceptance of any other project—that is, the project does not affect other projects. For example, if you have a large sum of money in the bank that you would like to spend on yourself, say, $150,000. You decide you are going to buy a car that costs about $30,000 and a new stereo system for your house that costs less than $5,000. The decision to buy the car does not affect the decision to buy the stereo—they are independent decisions.
" Mutually exclusive projects—in this case, the decision to invest in one project affects other projects because only one project can be purchased. For example, if in the above example you decided you were going to buy only one automobile, but you were looking at two different types of cars, one is a Chevrolet and the other is a Ford. Once you make the decision to buy the Chevrolet, you have also decided you are not going to buy the Ford.

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Answer 2

capital budgeting decision