Question

Using capital budgeting, recommend a capital investment project and discuss what value will it add to the firm and should the organisation take up the project or not?

the firm can be an educational institue or pharmaceutical company or any defined business.

Answer 1

Introduction: - Capital Budgeting is the process to identify whether the long term investment made by the organization in purchasing/ investing in the long term assets are worth investing. It also helps to identify the benefit that org. will be getting by investing in such assets/projects.

Capital Budgeting involves various techniques, some of the important and commonly used are: Payback method, Net Present value method, Accounting rate of return method, Internal Rate of Return method, etc.

Now if we take up an example of Hospital Industry: -

1. In Hospital Industry, the most important capital investment is the Hospital Premises.

Here it is to be taken care that hospital is located at the centre of the city so that it becomes remotely easy for people to reach the hospital in least time possible. But this will need higher cost since that locality might be very costly, being the centre of the city.

Here hospital authority shall consider the cost of premises and identify by capital budgeting whether they will receive the no. of patients that are required to recover the cost of the building.

Here the firm can follow either Payback method or Net present value method.

2. Second imp. Cost is Medical equipment cost.

The hospital can treat the patient only if they are well equipped to treat that patient. Without equipment it cannot treat any patient.

Here hospital shall consider the cost of the equipment with the help of Net Present value and can identify whether it is worth buying it or they shall go for some cheaper equipment.

3. Another important cost is Research and Development cost

Company can identify and decide the total cost of R&D required and with the help of Capital budgeting the can decide whether it is worth putting that much expenditure in R&D, after identifying the benefits that they are going to reap out of it.

Here they can make use of Payback method to apply capital budgeting principle over the firm`s long term investments.