Question

Explain the meaning of the "capital budgeting" decisions and compare them with the "financing decisions" of a firm. Who is typically in charge of each type of decision responsibility within the firm?

Answer 1

Capital budgeting is budgeting exercise for long term investments. For example: Purchase of machine, renovation projects, etc. Capital budgeting decision is generally irreversible in nature. They involve huge outflow of money and hence it is evaluated through various techniques like Payback period, accounting rate of return, net present value, etc.

Financing decisions involves raising capital through various methods of financing like long term loans, bonds, preferred stock or common stock. They are raised to fund the capex requirements of the organisation.

So Capital budgeting is utilization of finance raised through financing decision.

Capital budgeting is responsibility of each division or functional head. Capital budgeting exercise is usually done previous year for following year activities. It involves allocation of money to each function. Financing decisions is usually done by top management depending on various factors like debt equity ratio, cost of funds, etc