Capital budgeting process

Capital budgeting process

Introduction

financial management of every small or multinational organization primarily apprehensive about making effective investment, dividend and financing decision of its organization by keeping the accomplishment of organization mission and vision statement, and long term goals in mind (Megginson, et al, 2008). According to the global financial theory the prime objective of every organization it to maximize the wealth of its organization, and maximizing the wealth of its shareholders, and important stakeholders.

Financial decision of the organization is entirely dependent on its investment structure that comprises of either equity or dept. On the other hand dividend decision taken by the organization depends upon the distribution policy of income generated to the shareholders, whereas, investment decision of the organization comprises of firms ability to use its resources for effectively investing in the market for the sake of increasing market share (Harris & Raviv, 1996).

Discussion

Financial management of the company poses strong relationship with its future goal and capital budgeting, this relationship could be viewed from the diagram.

Figure 1: capital budgeting relationship in firms (Dayananda et al, 2002).

This chart clearly explains the relationship of capital budgeting with company's corporate financial team, and its performance. Generally, companies invest in either short term or long-term investment opportunities in the market; however, it uses the tools of capital budgeting for long-term investment such us investment in building, machinery, patents, and various others.

Organization after proper evaluation decides to either invest in tangible or intangible assets; however, organization decision of investing in a project could be analyzed from two important features (Peterson & Fabozzi, 2002). Firstly, organization investment could of specific time, or could be longer life project that are known to provide organization cash benefits for several years. Mean while, an investment decision could have long-term consequences for the organization, for instance, it could have a positive impact on Organization overall cash flows, could increase the risk for company, to improve organization performance, or could negatively affect the performance.

Classification of organization investment projects

As discussed above an organization can invest in either tangible or intangible product after analyzing its financial position (Dayananda et al, 2002). However, investment project are further divided into three types as independent project, mutually exclusive project, and a contingent project.

Independent project

If an organization decides to invest in an independent product will not affect the performance of other project of the company, and acceptance, or rejection of this project will not prevent management to invest in other projects. For example, an organization wants to expand its product line by introducing a new product in the market, and at the same time, organization is planning to replace an existing machine with a machine that has the capability of produce-diversified project simultaneously (Harris & Raviv, 1996).

In this scenario, organization can select both the projects depending on the financial performance, and investment criteria. For decision that is more effective organization can use capital budgeting tool like NPV, IRR, PBP, to analyze their value before deciding to accept or reject the ...