Table of Contents
- Factors influencing capital expenditure decisions
- 1. Availability of Funds
- 2. Minimum Rate of Return on Investment
- 3. Future Earnings
- 4. Quantum of Profit Expected
- 5. Cash Inflows
- 6. Legal Compulsions
- 7. Ranking of the Capital Investment Proposal
- 8. Degree of Risk and Uncertainty
- 9. Urgency
- 10. Research and Development Projects
- 11. Obsolescence
- 12. Competitors Activities
- 13. Intangible Factors
The following are the factors which are highly influencing Capital Expenditure decisions.
Factors influencing capital expenditure decisions
1. Availability of Funds
All the projects are not requiring the same level of investments. Some projects require huge amount and having high profitability. If the company does not have adequate funds, such projects may be given up.
2. Minimum Rate of Return on Investment
Every management expects a minimum rate of return or cut-off rate on capital investment. It refers to the point of below which a project would not be accepted.
3. Future Earnings
The future earnings may be uniform or fluctuating. Even though, the company expects guaranteed future earnings in total which affects the choice of a project.
4. Quantum of Profit Expected
It is necessary to assess the quantum of profit expected on implementation of selected project. Here, the term profit refers to realized amount of projects as per the accounting records.
5. Cash Inflows
The term cash inflows refers to profit after tax but before depreciation. The reason is that recording of depreciation is a book entry and there is no actual cash outflow. Hence, depreciation amount is included in the cash inflow.
6. Legal Compulsions
The management should consider the legal provisions while-selecting a project. In the case of leather and chemical industries, there are number of legal provisions created to protect environment pollution. Now, the management gives much importance to legal provisions rather than cost and profit.
7. Ranking of the Capital Investment Proposal
Sometimes, a company has two or more profitable projects in hand. If there is only one profitable project out of many and huge amount is available in the hands of management, there is no need of ranking of capital investment proposal. Ranking is necessary if there is many profitable projects in hand and limited funds is available in the hands of management.
8. Degree of Risk and Uncertainty
Every proposal involves certain risk and uncertainty due to economic conditions, competition, demand and supply conditions, consumer preferences etc. The degree of risk and uncertainty affects the profitability of the project. Hence, degree of risk and uncertainty of the project is taken into consideration for selection.
A project may be selected immediately due to emergency or urgency. The reason is that such immediate selection saves the life of the company i.e. survival of a company is the primary importance than other factors.
10. Research and Development Projects
Research and Development project is highly required for technology based industries. The reason is that there is a lot of changes made within short period in technology. The research and development project gives more benefits in the long run. Hence, profitability is getting less importance and survival of business is getting much importance in the case of research and development project.
The replacement of existing fixed assets is compulsory since there is an obsolescence of plant and machinery.
12. Competitors Activities
Every company should watch the activities of the competitors. The company should take a decision by considering the activities of the competitors. If so, the company can withstand in competition by implementing new projects.
13. Intangible Factors
Goodwill of the company, industries relations, safety and welfare of the employees are considered while selecting a project instead of considering profit alone. These factors are also high responsible for selection of any project.