ROMEO S. MARTIN, JR.

BS ACCOUNTANCY

FIN3N FINANCIAL MANAGEMENT 2 PROF. MICHAEL AUDITOR, CPA, MBA Synthe ! "n C#$!t#% B&'(et!n(

There comes a time when management decides to pursue long-term, high-cost projects of which risks are involved. They are given choices and a choice stands out among others. One process of choosing among alternatives come with capital budgeting. Capital budgeting is the process of planning and controlling investments for longterm projects and programs. Capital investment should be evaluated thoroughly and carefully because: !" capital budgeting decisions tend to be relatively infle#ible for the commitments e#tend well into the future$ %" without proper timing, additional capacity generated by the ac&uisition of capital assets may not coincide with changes in demand for output, resulting in capacity e#cess or shortage$ and '" a capital budget usually involves substantial e#penditures. Capital budgeting re&uires choosing among investment proposal, such that ranking procedure is needed to come up with decisions. (irst, determine the asset cost or net investment. The net investment is net outlay, or gross cash re&uirement, minus cash recovered from the trade or sale of e#isting assets, with any necessary adjustments for applicable ta# conse&uences. Cash outflows in subse&uent periods must also be considered. The investment re&uired also includes funds to provide for increases in working capital, for e#ample, the additional receivables and inventories resulting from the ac&uisition of a new manufacturing plant. This investment in working capital is treated as an initial cost of the investment a cash outflow" that will be recovered at the end of the project. )econdly, calculate estimated cash flows, period by period, using the ac&uired assets. Third, relate the cash-flow benefits to their cost-by

ROMEO S. MARTIN, JR. BS ACCOUNTANCY

FIN3N FINANCIAL MANAGEMENT 2 PROF. MICHAEL AUDITOR, CPA, MBA

using one of several methods to evaluate the advantage of purchasing the asset. (ourth, rank the investments. The techni&ues that may be applied in evaluating capital investment approach are essentially the discounted cash flow approaches and the nondiscounted cash flow approaches. *nder the discounted cash flow approaches are the internal rate of return, net present value and profitability inde#. *nder the nondiscounted cash flow approaches are the payback period, payback reciprocal and accounting rate of return. +n reflection, a financial manager, or a team of financial decision-makers, must be adept with capital budgeting to avoid further costs in the future and to create the optimal balance between costs and benefits.