Capital budgeting is concerned with :
Evaluating the returns and investment in projects.
Evaluating the returns and investment in projects — option 4.
What capital budgeting is. The process of planning and evaluating expenditure on assets whose returns are expected over a period longer than one year — the long-term investment decision of the firm. It answers the question which projects should we undertake, by comparing the outlay required against the returns expected.
The three core financial decisions, which is what the four options are drawn from :
| Decision | Question it answers | Option here |
|---|---|---|
| Investment (capital budgeting) | In what long-term assets should the firm invest? | 4 |
| Financing | How should those investments be paid for —> debt or equity, and in what mix? | 1 — arranging cash resources is the financing decision, not the evaluation |
| Working capital / liquidity | How should current assets and liabilities be managed day to day? | 2 |
Option 3 — managing fixed assets through repairs and renewals —> is maintenance, an operating matter. It concerns assets already acquired; capital budgeting concerns whether to acquire them at all.
Why the decision matters so much. Capital budgeting decisions are the most consequential a firm takes, and for three reasons: they involve large sums, they are substantially irreversible once the plant is built, and they commit the firm to a line of business for years. A financing mistake can be refinanced; a bad plant cannot easily be unbuilt.
The evaluation techniques, since “evaluating the returns” is the operative phrase :
| Family | Techniques | Comment |
|---|---|---|
| Discounted (time-adjusted) | Net present value, internal rate of return, profitability index, discounted payback | Theoretically correct; NPV is the preferred criterion because it measures the addition to shareholder wealth directly |
| Traditional (non-discounted) | Payback period, accounting rate of return | Simple, but ignore the time value of money; payback also ignores everything after recovery |
The steps of the process : identify investment opportunities, estimate the incremental cash flows, evaluate them by an appropriate criterion, select and authorise, implement, and finally conduct a post-completion audit comparing outcome with forecast — which is what makes the next round of estimates better.
Hence, the answer is Evaluating the returns and investment in projects.
Similar Questions
A public works project is proposed that has total present-worth benefits of ₹ 75 million and total present-worth cost of ₹ 55 million. In deliberating this proposal, some members of the Municipal Board have suggested that the project has a total present-worth disbenefits of ₹ 15 million; other members feel that ₹ 15 million should be treated as a cost. What will be the benefit cost ratio and net benefits value while considering the disbenefits as a cost?
Select the correct statement/s from the following :
Statement I : The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II : To find total NPV of more than one projects, their NPV cannot be added.
Statement III : The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV : The risk - adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
Codes :
Indicate the correct code for the combination from the following regarding the superiority of the wealth maximisation over the profit maximisation objective of the financial management :
(a) It takes into account long term stability and survival of the firm.
(b) It takes care of all other objectives of the firm like exploring and expanding markets, etc.
(c) It is based on the assumption of perfect competition in the market.
(d) It considers risk alongwith returns.
Code :
Which combination of the following statements about the net present value method of the investment project appraisal is correct ?
(a) It considers all the cash flows from the project
(b) It gives more weightage to distant flows than near-term flows
(c) It considers the time value of money
Code :
In which of the following appraisal criteria of capital budgeting, the use of varying opportunity cost of capital as a discount factor is possible ?
(a) NPV
(b) IRR
(c) Pay-back Period
(d) ARR
Select the correct statement/s from the following:
Statement I: The slope of the NPV profile reflects how sensitive the project is to discount rate changes.
Statement II: To find total NPV of more than one projects, their NPV cannot be added.
Statement III: The certainty equivalent coefficient applies adjustments to both, the cash flows (in the numerator) and the discount factor (in the denominator).
Statement IV: The risk-adjusted discount factor applies adjustment for risk only to the discount factor (denominator).
Codes:
Statement – I : In general, the NPV and IRR methods lead to the same acceptance or rejection decision when a single project is involved.
Statement – II : The inconsistency in ranking of competing projects as per the NPV and IRR methods lies in the implicit assumptions with regard to different rates of returns on re-investment of intermediate cash flows.
Code :
Under the Modified Accelerated Cost Recovery System (MACRS) an asset in the “5 year property class” would typically be depreciated over how many years ?
In case the firm makes varying investments on the different investment projects, the appropriate project evaluation technique would be, which one of the following?
A company issues 11% debentures of ₹ 100 each for an amount aggregating ₹ 2,00,000 at 10% premium, redeemable at par after 5 years. The company tax rate is 40%. The cost of debt is:
Important Questions from Capital Budgeting
A firm is currently earning Rs. 50,000 and its one share has a present market value of Rs. 175. It has 5,000 shares outstanding. The earnings of the firm is expected to remain stable and it has a payout ratio of 100%. The cost of equity is:
With project cost of ₹300 lacs, profits after depreciation (straight line method) and tax for its lifetime of 5 years are estimated at ₹10 lacs, ₹10 lacs, ₹30 lacs, ₹40 lacs and ₹50 lacs respectively. The cost of capital is 12% and discount factors @ 12%, for the first five years are 0.89, 0.80, 0.71, 0.64 and 0.57 respectively. The Net present value of project is :
Match List I with List II
LIST I
(Investment Decision rule)
LIST II
(Feature)
A. NPV I. Insufficiently consistent B. Payback II. Highly Inflexible C. Cash Returns III. Balance between flexibility and consistency D. Accounting Returns IV. Relatively consistent Choose the correct answer from the options given below:
Which of the following are assumption of Net Operating Income Approach of Capital Structure?
(A) There is no Corporate Tax
(B) Cost of debt remain constant at all level
(C) The Business risk remain constant every level of debt and equity mix
(D) The cost of Debt is less than cost of equity
(E) Overall cost of Capital remain constant
Choose the correct answer from the options given below:
Fixing the zero date is important step in establishing a project-
