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Capital budgeting is the process of making investment decisions in capital expenditure. It involves the planning and control of capital expenditure. It is the process of deciding whether or not to commit resources to a particular long term projects whose benefits are to be realized over a period of time.
Capital budgeting decision involves large investment of funds. but funds available with the company are always limited and the demand for funds far exceeds the resources. As such it is very important for a firm to plan and control its capital expenditure.
There is a long term commitment of funds which increases the risk . the greater the risk involved , the greater the need for careful planning of capital expenditure.
The capital expenditure decision is of irreversible nature and have a long term and significant effect on the profitability of a company. Not only the present earnings of the company are affected by the investments in capital assets but also the future growth and profitability of the firm depends upon the investment decisions taken today.
Therefore any unwise decision may prove disastrous and fatal to the very existence of the concern.
It is also important to not that investment decision though taken by individual entity is of national importance because it determines employment, economic activities and growth.
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