CHAPTER 1

1.1 INTRODUCTION
Capital budgeting, also known as investment appraisal, is a key financial practice used by organizations
to evaluate potential large projects or investments. This process involves planning and managing long-
term investments to maximize shareholder value and ensure efficient capital allocation. The essence of
capital budgeting is that it helps decision makers choose the best investment targets and ensure that
the selected projects contribute positively to the financial position and strategic goals of the company.
The focus of capital budgeting is the evaluation of the profitability and financial profitability of
investment projects. This assessment requires a thorough analysis of the expected cash flows associated
with the project. The main objective is to determine if the benefits of the investment exceed the costs,
which creates added value for the organization. This evaluation process is crucial because it helps
companies avoid bad investment decisions that can lead to financial losses or lost growth opportunities.
An important part of capital budgeting is estimating future cash flows. These cash flows indicate the
expected benefits of the investment and are decisive in determining the value of the project. An
accurate forecast of these cash flows is essential because even small errors can lead to significantly
different conclusions about the profitability of the project. Companies must consider various factors
such as market conditions, competition, technological developments and regulatory changes, all of
which can affect future cash flows. The time value of money is another important concept in capital
budgeting. He recognizes that a dollar today is worth more than a dollar in the future because of its
potential earning power. This principle is central to the discounting of future cash flows into the present
value, which allows for a more accurate comparison of different investment options. By applying
discount rates, companies can consider the risks and opportunity costs associated with their
investments and ensure that they choose projects with the highest return relative to their risk profile.
Risk analysis is essentially related to capital budgeting. Every investment carries a certain level of risk, be
it market risk, credit risk, operational risk or liquidity risk. Companies must evaluate these risks to
determine the probability of expected returns. This means identifying potential uncertainties and their
impact on the cash flows and overall viability of the project. Effective risk management can improve the
accuracy of capital budgeting decisions and protect a company from unexpected adverse events. Master
budgeting also includes strategic orientation. Investments must be in line with the company's long-term
strategic goals and strengthen the competitive position. This strategic perspective ensures that the
selected projects not only generate a financial return, but also contribute to the achievement of the
broader goals of the organization, such as market expansion, technological innovation or sustainability.
Aligning capital investments with strategic priorities helps companies create a coherent and focused
growth strategy. In addition, capital budgeting is a dynamic process that requires continuous monitoring
and post-implementation review. Once a project is approved and launched, it is important to monitor its
progress and performance against initial projections. This continuous evaluation allows companies to
make necessary changes, address any issues that may arise and ensure that the project is within the
right boundaries to deliver the expected benefits. Post-commission reviews also provide valuable
insights and lessons that can inform future investment decisions and improve the overall capital
budgeting process. The role of capital budgeting extends beyond individual projects and encompasses
the overall financial strategy of the organization. It balances short-term financial constraints with long-
term growth opportunities. Companies must carefully manage their capital structure and ensure that
they have enough money to invest in profitable projects while maintaining financial stability. This
balance is crucial to maintaining economic growth and achieving economic flexibility. Capital budgeting
decisions also have significant implications for stakeholders, including shareholders, employees,
customers and the wider community. Shareholders are primarily interested in maximizing their
investment, while employees may be interested in job security and growth opportunities. Customers will
benefit from better products and services as a result of successful investments, and the community will
experience economic growth and development. Therefore, capital budgeting decisions must take into
account the interests of these various stakeholders to ensure sustainable and inclusive economic
growth. Ethical considerations play an important role in capital budgeting. Companies must conduct
investment appraisals honestly, openly and responsibly. Ethical practices ensure that decisions are made
in the best interests of the organization and its stakeholders, avoiding conflicts of interest, fraudulent
practices, or short-term gains at the expense of long-term sustainability. Adherence to ethical standards
of capital budgeting builds trust and credibility, which are essential to a company's reputation and long-
term success.