Question

what are examples of a capital budgeting decision?

Answer 1

Examples of capital budgeting decision:

On the basis of firm’s existence: The capital budgeting decisions are taken by both newly incorporated firms as well as by existing firms. The new firms may be required to take decision in respect of selection of a plant to be installed. The existing firm may be required to take decisions to meet the requirement of new environment or to face the challenges of competition. These decisions may be classified as follows:

(i) Replacement and Modernisation decisions: The replacement and modernisation decisions aim at to improve operating efficiency and to reduce cost. Generally all types of plant and machinery require replacement either because of the economic life of the plant or machinery is over or because it has become technologically outdated. The former decision is known as replacement decisions and latter is known as modernisation decisions. Both replacement and modernisation decisions are called cost reduction decisions.

(ii) Expansion decisions: Existing successful firms may experience growth in demand of their product line. If such firms experience shortage or delay in the delivery of their products due to inadequate production facilities, they may consider proposal to add capacity to existing product line.

(iii) Diversification decisions: These decisions require evaluation of proposals to diversify into new product lines, new markets etc. for reducing the risk of failure by dealing in different products or by operating in several markets.

Both expansion and diversification decisions are called revenue expansion decisions.

On the basis of decision situation: The capital budgeting decisions on the basis of decision situation are classified as follows:

(i) Mutually exclusive decisions: The decisions are said to be mutually exclusive if two or more alternative proposals are such that the acceptance of one proposal will exclude the acceptance of the other alternative proposals. For instance, a firm may be considering

proposal to install a semi-automatic or highly automatic machine. If the firm installs a semi-automatic machine it excludes the acceptance of proposal to install highly automatic machine.

(ii) Accept-reject decisions: The accept-reject decisions occur when proposals are

independent and do not compete with each other. The firm may accept or reject a

proposal on the basis of a minimum return on the required investment. All those

proposals which give a higher return than certain desired rate of return are accepted and

the rest are rejected.

(iii) Contingent decisions: The contingent decisions are dependable proposals. The investment in one proposal requires investment in one or more other proposals. For example, if a company accepts a proposal to set up a factory in remote area it may have to invest in infrastructure also e.g. building of roads, houses for employees etc.