Phases of Capital Budgeting

Capital Budgeting is a complex process which

may be divided into five broad phases: planning,
analysis, selection, implementation and review.
 Planning
This phase is concerned with the articulation of its
broad investment strategy and the generation
and preliminary screening of project proposals.
The investment strategy delineates the types of
investments the firm plans to undertake. Once a
project proposal is identified, a preliminary
analysis is done.
 Analysis
If the preliminary screening suggests a project is
worthwhile, then a detailed analysis of the
marketing, financial, economic, and ecological
aspects is undertaken. The focus is to gather,
prepare and summarise relevant information
about various project proposals being
considered. Based on this, stream of costs and
benefits associated with the project can be
defined.
 Selection
A wide range of appraisal criteria have been
suggested to select a project. The different
methods include Payback period, Accounting
rate of Return, Net Present Value, Internal rate
of return, Benefit cost Ratio Projects are
selected if they qualify a suitable hurdle/ cut-off
rate.
 Implementation
The implementation phase for an industrial
project consists of several stages: project and
engineering designs, negotiations and
contracting, Construction, training and plant
commissioning.
Project & Engineering Design- Includes site
probing and preparation, blueprint preparation,
plant designs, plant engineering, selection of
machineries and equipments.
Negotiations and Contracting- Includes
negotiating and drawing up of legal contracts
with respect to project financing, acquisition of
technology, construction of building and civil
works, utilities provision, supply of machinery
and equipment etc.
Construction- Includes site preparation,
construction of buildings and civil works,
erection and installation of machinery and
equipment.
 Training – Training of engineers, technicians
and workers. (This can also take place
simultaneously with the previous stage.)
 Plant commissioning – Start up of the plant.
Converting an investment proposal into a
concrete project is a complex, risky and time-
consuming task. For expeditious
implementation at a reasonable cost the
following is to be taken care of:
 Adequate formulation of projects
 Use of the Principle of Responsibility
Accounting
 Use of Network Techniques
 Review
Review phase begins after commissioning of the
project, to check between the actual and the
projected performance.
 Facets of Project Analysis
The important facets are:
 Market Analysis
 Technical Analysis
 Financial Analysis
 Economic Analysis
 Ecological Analysis
Market Analysis
 Consumption trends in the past and present
 Past and present supply position
 Production possibilities and constraints
 Imports and exports
 Structure of Competition
 Cost Structure
 Elasticity of Demand
 Administrative, technical and legal constraints
Technical Analysis
It seeks to answer the following questions:
 Preliminary tests and studies have been done?
 Availability of raw material, power, other inputs
established?
 Selected scale of operation is optimal?
 Production process chosen is suitable?
 Equipment and machines chosen are
appropriate?
 Auxilliary equipments and supplementary
engineering works have been provided for?
 Provision made for treatment of effluents?
 Proposed layout of the site, buildings, plant is
sound?
 Work schedules have been realistically drawn
up?
 Technology proposed to be employed is
appropriate from social point of view?
Financial Analysis
 Investment outlay and cost of project
 Means of financing
 Cost of capital
 Projected profitability
 Break-even point
 Cash flows of the project
 Investment worthwhileness judged in terms of
various criteria of merit
 Projected financial position
 Level of Risk
Economic Analysis (Social cost
benefit analysis)
It seeks to answer the following questions:
 Direct economic benefits and costs of the project
measured in terms of shadow (efficiency) prices &
not in terms of market prices?
 Impact on the distribution of income in the society?
 Impact on the level of savings & investment in the
society?
 Contribution towards fulfillment of certain merit
wants like self-sufficiency, employmeny, social
order?
Ecological Analysis
Ecological analysis is important for major projects
and answers the following questions:
 Any likely damage caused by the project to the
environment?
 Cost of restoration measures required to ensure
that the damage to the environment is
contained within acceptable limits?
 Feasibility Study
 The feasibility study is concerned with the first
three phases of capital budgeting, viz.,
planning, analysis, and selection and involves
market, technical, financial, economic and
ecological analysis.
 Generation of Ideas

Initial Screening

Idea Prima Facie

Good? No

Plan Feasibility Study Terminate

Conduct Market Conduct Technical

Analysis Analysis

Conduct Financial Analysis

Conduct Eco. & Ecological

Analysis

Project Worthwhile? No
Prepare Funding Terminate
Proposal
 Generation of Ideas
Barring truly new ideas which are based on
significant technological breakthroughs, most of
the project ideas involve combining existing
fields of technology or offering variants of
present products or services. To stimulate the
flow of ideas, the following are helpful:
 SWOT analysis
 Clear Articulation of Objectives
 Fostering a Conducive Climate
 Monitoring the Environment
The Important aspects studied in monitoring the
key sectors of the environment are as follows:
 Economic Sector
 Government Sector
 Technological Sector
 Socio-demographic Sector
 Competition Sector
 Supplier Sector
 Corporate Appraisal
An appraisal of corporate strengths and
weaknesses is essential for identifying
investment opportunities which can be profitably
exploited. The important aspects are:

Marketing and Distribution

Production and Operations

Research and Development

Corporate Resources and Personnel

Finance and Accounting
 Scouting for Project Ideas

A wide variety of sources should be tapped to
identify good project ideas:

Analyze the performance of existing Industries

Examine the inputs and outputs of various
industries

Review Imports and Exports

Study Plan Outlays and Govt. Guidelines

Look at the Suggestions of Financial Institutions
and Development Agencies

Investigate local materials and resources

Analyzse Economic and Social Trends

Study New Technological Developments

Draw Clues from Consumption Abroad

Explore the Possibility of Reviving Sick units

Identify Unfulfilled Psychological Needs

Attend Trade Fairs

Stimulate Creativity for Generating New Product
Ideas
 Preliminary Screening
The following aspects need to be looked into:
 Compatibility with the Promoter
 Consistency with Government Priorities
 Availability of Inputs
 Adequacy of the Market
 Reasonableness of Cost
 Acceptability of Risk Level