PURPOSE OF CAPITAL BUDGETING
The capital budgeting decisions are important, crucial and critical business decisions due to following reasons:
(i) Substantial expenditure : Investment decisions are related with fulfilment of long term objectives and existence of an organization. To invest in a project or projects, a substantial capital investment is required. Based on size of capital and timing of cash flows, sources of finance are selected. Due to huge capital investments and associated costs, it is therefore necessary for an entity to make such decisions after a thorough study and planning.
(ii) Long time period : The capital budgeting decision has its effect over a long period of time. These decisions not only affect the future benefits and costs of the firm but also influence the rate and direction of growth of the firm.
(iii) Irreversibility : Most of the investment decisions are irreversible. Once the decision implemented it is very difficult and reasonably and economically not possible to reverse the decision. The reason may be upfront payment of amount, contractual obligations, technological impossibilities etc.
(iv) Complex decision : The capital investment decision involves an assessment of future events, which in fact is difficult to predict. Further it is quite difficult to estimate in quantitative terms all the benefits or the costs relating to a particular investment decision.
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