Capital Budgeting

CAPITAL BUDGETING

- The planning and control of capital expenditures.

- The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing. Oftentimes, a prospective project's lifetime cash inflows and outflows are assessed in order to determine whether the returns generated meet a sufficient target benchmark. Also known as "investment appraisal".

CAPITAL EXPENDITURES

 refers to substantial outlay of funds the purpose of which is to lower cost and increase net income for several years in the future.

CLASSES OF CAPITAL EXPENDITURES

 REPLACEMENT INVESTMENTS

 EXPANSION INVESTMENTS

 PRODUCT-LINE OR NEW MARKET INVESTMENTS

 INVESTMENTS IN SAFETY AND/OR ENVIRONMENT PROJECTS

 STRATEGIC INVESTMENTS

 OTHER INVESTMENT

VALUATION

 is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability.

INVESTMENT

 is made when a firm spends some of its funds for the establishment of a project.

FORMS OF INVESTMENT

 INITIAL INVESTMENT

 LATER INVESTMENT

OBJECTIVES OF CAPITAL BUDGETING

 ESTABLISHING PRIORITIES

 CASH PLANNING

 CONSTRUCTION PLANNING

 ELIMINATING DUPLICATION

 REVISING PLANS

CAPITAL BUDGETING SYSTEM

 PREPARATION AND SUBMISSION OF BUDGET

 APPROVAL BUDGET

 REQUEST FOR APPROPRIATION

 SUBMISSION OF PROGRESS REPORTS

 POST APPROVAL REVIEWS

BUDGET REQUESTS

 are those made to include in the corporate budget capital projects which are felt to be desirable by those in the lower organization level.

APPROVAL OF THE BUDGET

 is a process which requires the following:

 Budget request are forwarded to top management.

 Top management decides which projects to recommend to the board of directors.

 Top management sends recommendations to the board of directors.

 The board of directors approves or disapproves the recommendations.

 Top management informs projects sponsors of the action taken on their projects.

REQUEST FOR APPROPRIATION

 The request and authority section

 The narrative section

 Supporting documentation section

SUBMISSION OF PROGRESS REPORTS

 To review the accuracy of the expenditures forecasts.

 To provide updated expenditures.

 To verify the assumptions and economics underlying the acceptance of individual projects.

POST APPROVAL REVIEWS

 To provide management with a standard method of evaluating the abilities and judgment of projects sponsors.

 To identify errors or patterns of error in judgment which can be avoided in future similar situations.

 To help ensure that the quality and accuracy of information attain the highest feasible standards.

EVALUATION OF PROPOSED CAPITAL EXPENDITURES

 URGENCY

 REPAIRS

 CREDIT

 NON-ECONOMIC FACTORS

 INVESTMENT WORTH

 RISK INVOLVED

METHODS OF ECONOMIC EVALUATION

 The payback method

 The average rate of return method

 The discounted cash flow methods:

1. Net present value method

2. Internal rate of return method

Exhibit 3

A SAMPLE INVESTMENT PROPOSAL FOR THE PURCHASE OF A MACHINE

Acquisition cost 10,000,000 pesos

Economic Life 10 years

Salvage value 100,000 pesos

Earnings and Costs per year

Income 5,000,000

Expenses -2,000,000

Net Income before tax and depreciation 3,000,000

Less: Depreciation (Straight line) 1,000,000

Net Income before tax 2,000,000

Less: Income