Chapter 9, Problem 1CC

Summary Introduction

Capital Budgeting:Capital budgeting is a process to evaluate various proposals related to investment and accept the effective one. In capital budgeting,firm allocates its financial resources in different fixed assets in such a way that the firms maximize return on investment.

To Explain:Capital budgeting and goals of capital budgeting.

Answer to Problem 1CC

• Capital budgeting is a process in which all the available investment opportunities are analyzed and firm will invest in effective one. Various methods are used to make an evaluation of opportunities forinvestment.

• The goal of capital budgeting is to accept or discard the investment proposal after the cash flows of the investment proposals are compared.

Explanation of Solution

Capital Budgeting is a step by step process that is used by businesses to determine the merits of an investment project.

It is important as it creates measurability and accountability. If any business wishes to invest its resources in a project, without considering the returns and risks involved in that project, the owners will treat it as irresponsible and in case a business has not developed any method of measuring the effectiveness of the investment decisions taken by them, then there are chances that the business will have very less chance of existence in the marketplace where there is competition.

• Capital budgeting is an important investment decision as it involves huge investment and is an irrevocable decision.

Goals of Capital Budgeting are as follows:

1. Search out new investment Projects
2. Estimation and forecast future cash flows
3. Facilitates the transfer of information
4. Control and Monitoring Expenditures
5. Creation of Decisions.

Conclusion

So, capital budgeting is a process in which all the opportunities of investment are compared on the basis of cash flows and effective one is accepted. In this way, return on investment can be maximized.