Business Studies Part I
Business Studies Part II

Factors affecting Capital Budgeting Decisions

Factors affecting Capital Budgeting Decision

A number of projects are always available to a business to invest in. But each project has to be evaluated carefully and depending upon the returns, a particular project is either Wealth Maximisation Concept selected or rejected. If there is only one project then its viability in terms of the rate of return viz., investment and its comparability with the industry’s average is seen. There are certain factors which affect capital budgeting decisions:

  • Cash flows of the project: When a company takes an investment decision involving a huge amount it expects to generate some cash flows over a period. These cash flows are in the form of a series of cash receipts and payments over the life of an investment. The amount of these cash flows should be carefully analyzed before considering a capital budgeting decision.
  • The rate of return: The most important criterion is the rate of return of the project. These calculations are based on the expected returns from each proposal and the assessment of the risk involved. Suppose, there are two projects A and B (with the same risk involved) with a rate of return of 10 percent and 12 percent, respectively, then under normal circumstances, project B will be selected.
  • The investment criteria involved: The decision to invest in a particular project involves a number of calculations regarding the amount of investment, interest rate, cash flows and rate of return. There are different techniques to evaluate investment proposals which are known as capital budgeting techniques. These techniques are applied to each proposal before selecting a particular project.

Factors affecting Capital Budgeting:

Availability of Funds

Working Capital

Structure of Capital

Capital Return

Management decisions

The need for the project

Accounting methods

Government policy

Taxation policy

Earnings

Lending terms of financial institutions

The economic value of the project