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Capital Budgeting: Chapter Seven

This chapter discusses capital budgeting and investment decision making. It covers identifying capital projects, estimating their costs, developing a master list, and creating a multi-year capital budget and program. The chapter also explains that capital budgeting involves long-term commitments, large funds, and assessing future events. It discusses evaluating expenditure decisions using criteria like costs, benefits, and how projects relate to organizational goals. Finally, it covers financing capital projects through pay-as-you-go or paying over an asset's useful life to spread out costs.

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Wendosen H Fitabasa
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29 views

Capital Budgeting: Chapter Seven

This chapter discusses capital budgeting and investment decision making. It covers identifying capital projects, estimating their costs, developing a master list, and creating a multi-year capital budget and program. The chapter also explains that capital budgeting involves long-term commitments, large funds, and assessing future events. It discusses evaluating expenditure decisions using criteria like costs, benefits, and how projects relate to organizational goals. Finally, it covers financing capital projects through pay-as-you-go or paying over an asset's useful life to spread out costs.

Uploaded by

Wendosen H Fitabasa
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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CHAPTER SEVEN

CAPITAL BUDGETING

Chapter objectives
At the end of this chapter the students will be able to:
Understand meaning of capital and budgets
Understand the importance of capital budgeting in marketing decision
making
Explain different types of investment project
 Understand the economic evaluation of investment proposals
Know the concept and calculation of net present value and internal rate
of return in decision making
 Capital budgeting or capital expenditure budget is a process of
making decisions regarding investments in fixed assets such as;-
land

 building

machinery or
furniture.

• The
word investment refers to the expenditure which is required to be
made in connection with the acquisition.
• CapitalBudget is also known as "Investment Decision Making or
Capital Expenditure Decisions" or "Planning Capital Expenditure"
etc.
• Capital budgeting is the process of identifying and selecting
investments in long-lived assets, or assets expected to produce ben­
efits over more than one year.
 capital budgeting is important because of the following
reasons:
Capital budgeting decisions involve long-term.
Capital budgeting involves commitment of large amount of
funds.
Capital decisions are required to assessment of future events.
budgeting decisions are irreversible.
Capital budgeting ensures the selection of right source of finance
at the right time.
Wrong sale forecast; may lead to over or under investment of
resources.
 Mechanism for formal decision making
7.1. Capital Improvements Program (CIP)
Capital improvement programs can help communities link
the annual budget for new or improved public facilities to
the long-term goals of the municipal plan.
•A capital improvements program is a blueprint for
planning a community's capital projects.
• CIP is a multiyear planning instrument used by
governments to identify needed capital projects.
•A CIP is not a static document.it should be review every
year.
The process for creating a capital budget and program typically includes
the following steps

1. Capital Inventory. The process generally begins by creating a complete


inventory of the municipality’s land, buildings, equipment, and so on.
2. Project Identification. Once the inventory is established, the next step is to
identify potential capital projects to be undertaken during the upcoming six
years.
Sources for identifying potential projects include the municipal plan, department
heads, planning and conservation commissions, and task forces or citizen groups.
3. Cost Estimates. The next step is to prepare and/or verify cost estimates for
identified projects.
Department heads are the obvious sources for this information, but it also may
be helpful to contact suppliers and professionals, such as engineers, architects, or
landscapers,
4. Initial Master List. Once cost estimates have been verified, the next
step is to include and tabulate all identified projects into a single master
list.
This often takes the form of a matrix with projects listed in separate rows
and the six-year planning period set out in columns across the top..
5. Tabulation of Debt Service. While the initial list of projects is being
prepared, it’s also a good time to tabulate the municipality’s current long-
term debt and associated debt service payments for each year of the six-
year planning period.
6. Draft CIP. The next step is to use all this information to prepare a draft
five -year capital budget and program of related expenditures, including
all expenditures for existing debt service.
7. Adoption. The capital budget and program may adopt, amended, or
repealed by legislative body following one or more warned public
hearings.
7.2.1. Elements of Capital Budgeting
1. Planning capital
budgeting requires a comprehensive planning effort. This effort includes a
number of elements:
(1) an inventory of existing capital assets
(2) a review of constituent demands for goods and services in the future, and
(3) a review of replacement needs of existing capital assets.
2. Cost analysis- Evaluating Expenditure Decisions
The most difficult decision faced by policymakers and administrators is
choosing which capital assets to acquire or replace,
These methods involve numerous criteria-quantitative, qualitative, and political.
The key is to match available revenue sources with a wide-ranging set of
expenditure options
Criteria can be developed that are most common are the following.
 Costs
of any particular project, facility, or equipment relative to competing projects, facilities, or
equipment
 Costs relative to benefits for competing projects, facilities, or equipment
 Relationship of the capital asset to the specific goals and objectives of the organization.
 Financial impact of the project on defined beneficiaries
 Capital costs relative to operating and maintenance costs
 Spin-off benefits of the capital asset to other public and private activities
 Effect on improved efficiency of organizational activities
 Political costs and benefits of the project
 Legal mandate of a project or activity mandated by law
 Chances for external funding
 Relationship to future needs and demands
3. Financing
There are two major modes of financing capital projects these are
 pay-as-you-go and
 pay-as-you-use

1) pay-as-you-go
The most conservative financing approach is pay-as-you-go.
This simply means that the expenditure of funds for a capital pay-
as-you-go all item does not occur until the money is in hand.
Debt is not incurred to fund all or a part of the capital item.
2)pay-as-you-use
financing should occur as the capital asset is used.
Incurring debt to fund such an item is logical because
the debt can be paid throughout the item's useful life. 
Itavoids great fluctuations in expenditures and revenues
not as pas as you go
ithelps spread the costs of the capital asset over a
number of years
Unit 7
End
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