Question

What is capital budgeting? How do relevant costs impact the capital budgeting process. How should a company use equity or debt to purchase capitalized assets? Support your answer.

Answer 1

Capital Budgeting :

Capital budgeting is the process a business undertakes to evaluate potential major projects or investments.As a part of Investment decisions, companies follow capital budgeting concept to analyse the Cash Inflows and Outflows thereby deciding if the investment gives the potential returns.

How do relevant costs impact the capital budgeting process ?

Relevant costs is the cost of future expected to be different or be affected by an election decision making among various alternatives. Relevant costs is the cost of a future that is different for each alternative.Since relevant cost is case specific and is incurred only if particular alternative choosen or Investent decision taken,Hence relevant costs should be added to the cost of project outflows.

How should a company use equity or debt to purchase capitalized assets?

Companies usually have a choice as to whether to seek debt or equity financing.The choice depends on the companies accesssibility to the funds.

• The main advantage of Equity financing is that there is no obligation to repay the money acquired through it and the disadvantage is you will have to share your profits and consult with your new partners any time you make decisions affecting the company.
• The advantages of debt financing is that the lender has no control over your business but the disadvantage is Debt is a bet on your future ability to pay back the loan.Though the compay earns profit or not,the interest on loan cannot be delayed.Hence the company has a fixed payout obligation.

considering the above factors,Company should use equity or debt according to its nature of business and availability of funds and future outcomes from the investment decision made