Types of Capital Budgeting Decisions

Types of capital budgeting decisions

Generally the business firms are confronted with three types of capital budgeting decisions.

(i) The accept-reject decisions;
(ii) mutually exclusive decisions; and
(iii) capital rationing decisions.

1. Accept-reject decisions: Business firm is confronted with alternative investment proposals. If the proposal is accepted, the firm incur the investment and not otherwise. Broadly, all those investment proposals which yield a rate of return greater than cost of capital are accepted and the others are rejected. Under this criterion, all the independent proposals are accepted.

2. Mutually exclusive decisions: It includes all those projects which compete with each other in a way that acceptance of one precludes the acceptance of other or others. Thus, some technique has to be used for selecting the best among all and eliminates other alternatives.

3. Capital rationing decisions: Capital budgeting decision is a simple process in those firms where fund is not the constraint, but in majority of the cases, firms have fixed capital budget. So large amount of projects compete for these limited budgets. So the firm rations them in a manner so as to maximize the long run returns. Thus, capital rationing refers to the situations where the firm has more acceptable investment requiring greater amount of finance than is available with the firm. It is concerned with the selection of a group of investment out of many investment proposals ranked in the descending order of the rate or return.