Scope of Capital budgeting decisions
Generally, the capital budgeting decisions are related to long term investments. The general scope of capital budgeting decisions are discussed briefly below.
1. Mechanization of Process: The manual production process is replaced by mechanization of process. The very purpose of this type of change is to reduce costs. The future cash inflows on this investment are the savings resulting from the lower operating costs. Now, the company considers the worth of mechanization of process.
2. Expansion Decisions: Sometimes, a company can expand its operation by increasing production and sales. In this context, a company can acquire new machinery, construct additional building, merger or takeover of other business. They require huge amount and evaluate future earnings.
3. Replacement Decision: A company can replace an old machine with a new machine by considering latest technology. It brings down the operating expenses and increase the productivity. Such replacement decision will be evaluated in terms of savings in operating costs or the cash profits from additional volume of production by new machine or both.
4. Buy or Lease Decision: The fixed assets can be purchased or arranged on lease arrangements. The purchase of fixed assets requires huge amount initially. If the same asset is used on lease basis, the company requires less amount initially and heavy amount in total. Hence, a comparative study can be made with reference to future benefits from these two mutually exclusive alternatives.
5. Choice of Equipment: Two types of machines are available to perform a same work. The cost of each machine differ from one another. Moreover, pros and cons of buying each machine are evaluated and screened for selection of best one. Capital budgeting process helps a lot in such selections.
6. Product or Process Innovation: A new product may be find out or innovated. Sometimes, a new production process may be innovated. The research and development department of a company is finding a new product or innovation in a product or process. These require huge amount for implementation. In this case also, a comparative study of net cash outflow (costs of the project) and net cash inflow (i.e. future earnings) is highly useful for taking a decision. The decision is based on the profitability of the product or process.
7. Housekeeping Projects: These projects are creating an indirect impact on production. Such projects are legally required for implementation and useful for the boost up the morale and level of motivation among the employees. Health and safety projects, service department projects, welfare projects, education, training and development projects, status projects and research and development projects are the examples of Housekeeping Projects. The financial feasibility, quantum of amount required, sources of finance and profitability of the housekeeping projects are not considered for implementation.