Question

Define Capital Budget and what is its purpose and objective?

Answer 1

Capital budget is a budget that aims to allocate the long term funds into long term investments, be it equipment, plant,machinery or a even a project

Like every other project the purpose of capital budget is also effective utilization of resources since the investments are made in large amount it requires deep analysis before allocating money among projects and for this  purpose of assessing the viability of a particular investment there are different tools that can be used like NPV,IRR and payback period etc. And this process is called capital budgeting

As far as the objectives are concerned the primary objective of capital budget or capital budgeting process is maximise shareholder wealth this leads us to other objectives like

Selection of most profitable projects amung all which suit firms risk and return profiles.

Determine the capital budget i.e. the maximum amount of funds company needs.

Determine the funding source i.e. from where will the funds be raised though there are many sources like common stock,preferred stock,bonds,bank loan etc. Firm can choose any one or choose multiple sources so as to minimise the overall cost of funding.

Selection of those profitable projects which fits in the the budget so determined.

Determine the payback period of project so chosen as to in how many years our investment will start providing returns.

Controlling the project cost as the project progresses so as to keep it in budget basically this process is continued untill the project achieves its payback period.