Question

Evaluate why the profitability of a corporation is largely based on how successful management is in making the soundest capital budget investment decisions. (there is already a question posted with an answer, please do not copy and paste it)

Answer 1

The investment decisions that are concerned with commitment of funds to the long-term assets that are primarily meant to create, develop and upgrade its operating infrastructure, are called Capital Budgeting Decisions.

From the point of view of Finance manager, capital budgeting is a decision-making process that involves the recognition and evaluation of investment proposals that are valuable to the business organization. The profitability of a corporation is largely based on how successful management is, in making the soundest capital budgeting investment decision. This is because of the following reasons:

• Expansion: The selection of the most appropriate project where the firm seeks to increase its sales of current products or introduce new products to the market, will raise the level of profitability so that the value of firm also stands increased.
• Product improvement: Existing products with additional functionality and utility is the essence of product improvement. A successful improvement in the product of the firm by investing in the right direction will increase the profitability of the organization in near future.
• New product development: In order to set-up new research and development facility and also to improve existing facilities, projects are undertaken for new product development. Such new products tend to pose a real threat to the existing competitor firms and drastically improve the market value of the firm, resulting in higher profitability.
• Diversification: It is a business strategy to minimize the business risk. It involves diversification into variety of product lines so that a lower profitability or losses due to sluggish demand in one product line is compensated by more profitable lines of production. New product lines require additional equipments and machinery that culminates in a capital budgeting decision.
• Cost savings: The cost reduction is effected by implementing new technologies that require replacement projects where the firm must either replace the worn out equipment projects or invest in new technologically superior equipment. This results in lower current production costs besides an increase in current sales and also profitability of the firm.

-- Thus, a successful capital budgeting investment decision by the management leads to a higher degree of profitability in a firm.