The capital budgeting decision has been a very typical issue in the sustenance of a company. Several companies have lost their identity or liquidated due to wrong capital budgeting decision they made at a particular point of time. Based on these common problems in industries and the effect of globalization on industries, it is important to use effective method before making any investment decision.

Capital budgeting is extremely important because the decision made directly affects the organization future growth.

Importance of Capital budgeting to organization:

Effective capital budgeting helps to improve the timing of asset acquisition and the quality of assets purchased

When asset acquisition is planned properly, the organization is able to acquire and install in a manner

Generally all organizations tend to order capital goods at the same time when sales in a particular industry are increasing strongly.

Capital budgeting is a process in which a business determines whether projects such as building a new plant or investing in a long term venture are worth or not. Most of times, a prospective project’s lifetime cash inflow and outflows are assessed in order to determine whether the return generated meet a sufficient target. Capital budgeting is also known as Investment Appraisal. Ideally, business should do all those projects and opportunities which enhance shareholders value. Generally, businesses prefer to study a project before taking it on, as it has a great impact on the company’s financial performance. Capital budgeting is an important tool. One important duty of a financial manager is to choose investments with satisfactory cash inflows and rate of return. A financial manager should be able to decide if an investment is worth undertaking and should also have the ability to choose intelligently given other alternatives. Capital budgeting is primarily concerned with sizable investments in long term assets. These assets can either be tangible items such as property, plant & machinery or intangible ones such as new technology, patents or trademarks. Investments in processes such as research, design and development and testing- through which new products are created may also be viewed as investments in tangible assets. (Don Dayananda et al 2002)

1) Why is the investment appraisal process so important?

Investment appraisal means to check out whether an investment or a project is acceptable, profitable for business or not. Investment appraisal is related with a long term projects which involves huge amount of funds of the company. Investment appraisal process is helps the management to take a very important decision about the future investment.

Company’s main aim is increase the shareholder’s fund. For this company has to invest in new projects, to judging investment appraisal process help the management or manager to take a rite decision. Investment appraisal process is very important for the company because before accepting any project firm has to analyse all available projects that which one is beneficial for the organisation, otherwise if the firm has take wrong decision which is going to making loos in firm and which decrease the shareholder’s fund.

Many companies lost their identity or bankrupts because of the wrong investment decision. If the organisation takes rite decision that helps it to increase its wealth, market share, value, assets. Investment appraisal is a game in which manager has to take rite decision or manage cash inflows and cash out flows, so with help of it company get maximum return.

2) What is the payback period of each project? If AP Ltd imposes a 3 year maximum payback period which of these projects should be accepted?

Here we have two projects A and B. The calculation of PBP of both project are as below. Company has decided to accept that project which has less payback period of 3 years.

Calculation of PBP of project A:-

Year

Net cash flow

Cumulative net cash flow