Summary
Capital Budgeting Summary
- Institution
- University Of Cape Town (UCT)
Detailed and well summarised study notes of the capital budgeting section taught in financial management at UCT (FTX2024S).
[Show more]
Seller
Follow
Content preview
CAPITAL BUDGETINGWHAT IS CAPITAL BUDGETING?
- the analysis and evaluation of investment projects that normally produce future
economic benefits over a number of years to increase the value of the firm
- must consider entire project’s life before deciding to go ahead with project or not
- financial cash outlay will be upfront
- benefits (future cash flows) received over a number of years
Capital investment decisions
- decision to invest in a project (initial cash outflow) resulting in long term future cash
inflows and outflows
- investment decision is taken 1st
- then the financing (leasing, borrowing, and purchasing) decision
Why is the capital budgeting decision NB for the firm?
The SOFP:
- SOFP includes past capital budgeting decisions (Relevance and Feedback Value)
- tactical & strategic Investments → future wealth creation for shareholders
Consequences of investment & non-investment:
- analyse the SCF to evaluate investment intention, to increase the # of the firm
Investment risks:
- over capacity → high overheads – inefficiencies – lower profits
Non-investment risks:
- under capacity resulting in loss of market shar (lower profits)
- higher operating costs → sweating assets more frequent breakdowns
- loss of investment flexibility → large investment results in company losing option to
invest elsewhere
- focus should be on project and wealth creation in the future
CAPITAL BUDGETING PROCESS
1. Strategic plan
2. Proposal generation
3. Review and analysis
4. Decision making
, 5. Implementation
- after project has been approved the cash expenditures are made
6. Follow up (post project audit)
- annual results are monitored & the actual annual CFs are compared to the estimated
CFs
TYPES OF INVESTMENT PROJECTS
Whether a firm can undertake a depends on the importance of the project to the existing
operations, availability of capital, types of finance to be used
* firm has unlimited funds → all projects increasing value of firm accepted and implemented
* firm capital rationing → only accept projects high on priority list & within budget constraints
Types of projects that may be entered into for strategic financial reasons:
1. Replacement & expansion decisions
- replacement: firm intends to maintain existing level of operations (production)
- new machine may result in improved production operations, costs & ↑ profits
- Expansion: firm intends to ↑ productive capacity to ↑ sales of existing products or to
diversify into new product lines.
- globalisation increased competition forcing firms to diversify into new product lines to
remain competitive
2. Independent projects
- acceptance of one project doesn’t preclude others from being considered (so long as
firm has enough $ & min investment criteria met)
- no competition between independent projects
3. Mutually exclusive projects
- alternatives that serve the same function
- acceptance of one project in a group of mutually exclusive projects prevents all other
projects from the group from being chosen
4. Contingent projects
- acceptance of one project is contingent on acceptance of another
- e.g. electricity company builds power plant, it must also invest in pollution control
equipment to comply with legal environmental requirements
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through EFT, credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying this summary from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller tylertmarshall. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy this summary for R60,00. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
72042 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy summaries for 14 years now