Question

What are some of the practical problems of capital budgeting in large corporations?

Answer 1

Capital budgeting is the process of determining the viability to long-term investments on purchase or replacement of property plant and equipment and other capital investments in business. However there are some practical problem on which decision are to be taken by the management.

1.) Involves Huge investment: As the investment in capital projects involves huge outflow of company resources there is greater need for proper planning through capital expenditure.This will affect the company cash flows as huge outflow of cash occurs.

2.) Irreversable: Capital investment decision once taken are very difficult to reverse. It is imporatant because most capital assets are business shall be customised according to the needs of business, hence disposal of those assets without proper usilisation shall incur losses to the organisation.

3.) Capital investments involves Risk: Before investing in capital assest it is paramount to properly plan the acquisition of the asset or development as they are used for longterm and they posses greater financial risks., like obsolescence of technology, etc

4.) Funding for the project:Since capital investments involves larger outflow of organisational resources it is important for the finance department to identify the source of fund. Also they require the altered business plan and cash flows to show profitabity in the future.

5.) Return on investment and Payback period: It is also important to estimate and analyse the benefits of the investment and determin the estimated payback period. Hence, Proper capital budgeting planning is must.