Concept Of Capital Budgeting

Capital budgeting, also known as an “investment appraisal,” is a financial

management tool to measure a project's potential risks and expected long-term
return on investment. Companies may have limited resources for new projects
so they carefully consider the capital investment a project requires and the
amount of value they expect to receive.
Financial decision-makers use capital budgeting to make well-informed
decisions about which projects they choose to approve and pursue. Companies
can also use capital budgeting throughout the project to measure its progress
and ensure it is adding the expected value.
Advantages of Capital Budgeting
 Capital budgeting helps a company understand the various risks
involved in an investment opportunity. And how these risks affect
the returns of the company.
 It helps the company to estimate which investment option would
yield the best possible return.
 A company can choose a technique/method from various
techniques of capital budgeting to estimate whether it is financially
beneficial to take on a project or not.
 It helps the company to make long-term strategic investments.
 It helps to make an informed decision about an investment
considering all possible options.
 All the techniques/methods of capital budgeting try to increase
shareholders’ wealth and give the company an edge in the market.
 It helps a company in a competitive market to choose its
investments wisely.
 Capital budgeting presents whether an investment would increase
the company’s value or not.
 It offers adequate control over expenditure for projects.
 Also, it allows management to abstain from over-investing and
under-investing.
Disadvantages of Capital Budgeting
 Capital budgeting decisions are for the long term and are majorly
irreversible in nature.
 These techniques are mostly based on estimations and assumptions
as the future will always remain uncertain.
 Capital budgeting still remains introspective as the risk factor, and
the discounting factor remains subjective to the manager’s
perception.
 A wrong capital budgeting decision can affect the company’s long-
term durability. And hence it needs to be done judiciously by
professionals who understand the project well.