What are the different phases of capital budgeting?

Capital budgeting is a very complex process which can be divided into five
phases:

Planning

Analysis

Selection

Implementation

Review

levels of desion making

Decisions are made at different levels in an organisation's hierarchy:

Strategic decisions are long-term in their impact. They affect and shape the
direction of the whole business. They are generally made by senior
managers. The managers of the bakery need to take a strategic decision
about whether to remain in the cafe business. Long-term forecasts of
business turnover set against likely market conditions will help to determine if
it should close the cafe business.

Tactical decisions help to implement the strategy. They are usually made by
middle management. For the cafe, a tactical decision would be whether to
open earlier in the morning or on Saturday to attract new customers.
Managers would want research data on likely customer numbers to help them
decide if opening hours should be extended.

Operational decisions relate to the day-to-day running of the business. They

are mainly routine and may be taken by middle or junior managers. For
example, a simple operational decision for the cafe would be whether to
order more coffee for next week. Stock and sales data will show when it
needs to order more supplies.

What are the facts of project analysis

Market analysis of a project

Technical analysis of a project
Financial analysis of a project
Economic analysis of a project
Ecological analysis of a project

The important facts of project analysis are as follows

Market analysis
Market analysis is associated primarily with two questions:
What would be the collective demand of the planned product / service in
future?
What would be the market share of the project under evaluation?
To answer the above questions, the market analyst needs a broad variety of
information and suitable forecasting methods. The kinds of data required are:
Consumption trends in the past and the present expenditure level
Past and present supply situation
Production potential and constraints
Imports and exports
Formation of competition
Cost structure
Flexibility of demand
Consumer manners and conduct, intentions, motivations, attitudes,
preference, and needs.
Allocation channels and marketing guidelines in use
Administrative, technical, and legal constrictions.

Technical analysis
Examination of the technical and engineering characteristics of a project
needs to be done repeatedly when a project is made. Technical analysis seek
out to decide whether the fundamentals for the successful commissioning of
the project has been considered and reasonably good options have been
made with respect to location, size, process etc. The important questions
raised in technical analysis are the following
Whether preliminary tests and studies have been done?
Whether the availability of raw materials, power, and other inputs has been
recognized?
Whether the production method opted is suitable?
Whether the equipment and machines chosen are suitable?
Whether the supplementary equipments and auxiliary engineering works
have been given for?
Whether provision has been made for handling of effluents?
Whether the planned layout of the site, building, and plant is sound?
Whether work schedules have been reasonably drawn up?
Whether the technology planned to be employed is suitable from the social
plant of view?

Financial analysis
Financial analysis tries to ascertain whether the planned project will be
financially feasible in the sense of being able to meet the saddle of servicing
debt and whether the planned project will convince the return expectations of
those who provide the capital. The feature that have to be looked into while
conditioning financial appraisal are the following:
Investment pay out and cost of project
Means of financing
Cost of capital
Projected profitability
Break-even point
Cash flow of the project
Investment worth while ness judged in terms of a variety of standards of
merit
Projected financial position
Level of risk

Economic analysis
Economic analysis is also referred to as social cost benefit analysis and is
concerned with evaluating a project from the larger social point of view. In
such a judgement the focus is on the social costs and benefits of a project
which may usually be different from its economic costs and benefits. The
questions sought to be answered in social benefit analysis are the following
What are the direct economic benefits and costs of the project measured in
terms of efficiency prices and not in terms of market prices?
What would be the impact of the project on the allocation of income in the
society?
What would be the outcome of the project on the level of savings and
investment in the society?
What would be the involvement of the project towards the achievement of
certain merit wants like self-sufficiency, employment, and social order?

Ecological analysis
In recent years, environmental concerns have assumed a great deal of
importance and rightly so. Ecological analysis should be done particularly
for major projects which have significant ecological inference like plants and
irrigation schemes, and environmental polluting industries like bulk drugs,
chemicals and leather processing. The key questions raised in ecological
analysis are the following
What is the likely harm caused by the project to the environment?
What is the cost of reinstatement measures needed to make sure that the
damage to the environment is contained with in acceptable limits?
feasibility study

In simple terms, a feasibility study involves taking a judgment call on whether

a project is doable. The two criteria to judge feasibility are cost required and
value to be delivered. A well-designed study should offer a historical
background of the business or project, a description of the product or service,
accounting statements, details of operations and management, marketing
research and policies, financial data, legal requirements and tax obligations.
Generally, such studies precede technical development and project
implementation.

A feasibility study evaluates the project's potential for success; therefore,

perceived objectivity is an important factor in the credibility of the study for
potential investors and lending institutions. [Source: Wikipedia]

PMP Certification

Five Areas of Project Feasibility:

Technical Feasibility - assessment is centered on the technical resources

available to the organization. It helps organizations asses if the technical
resources meet capacity and whether the technical team is capable of
converting the ideas into working systems. Technical feasibility also involves
evaluation of the hardware and the software requirements of the proposed
system.
Economic Feasibility - helps organizations assess the viability, cost, and
benefits associated with projects before financial resources are allocated. It
also serves as an independent project assessment, and enhances project
credibility, as a result. It helps decision-makers determine the positive
economic benefits to the organization that the proposed system will provide,
and helps quantify them. This assessment typically involves a cost/ benefits
analysis of the project.
Legal Feasibility - investigates if the proposed system conflicts with legal
requirements like data protection acts or social media laws.
Operational Feasibility - this involves undertaking a study to analyze and
determine whether your business needs can be fulfilled by using the
proposed solution. It also measures how well the proposed system solves
problems and takes advantage of the opportunities identified during scope
definition. Operational feasibility studies also analyze how the project plan
satisfies the requirements identified in the requirements analysis phase of
system development. To ensure success, desired operational outcomes must
inform and guide design and development. These include such design-
dependent parameters such as reliability, maintainability, supportability,
usability, disposability, sustainability, affordability, and others.
Scheduling Feasibility is the most important for project success. A project will
fail if not completed on time. In scheduling feasibility, we estimate how much
time the system will take to complete, and with our technical skills we need
to estimate the period to complete the project using various methods of
estimation.
Benefits of Conducting a Feasibility Study
Conducting a feasibility study is always beneficial to the project as it gives
you and other stakeholders a clear picture of your idea. Below are the key
benefits of conducting a feasibility study:

Gives project teams more focus and provides an alternative outline.

Narrows the business alternatives.
Identifies a valid reason to undertake the project.
Enhances the success rate by evaluating multiple parameters.
Aids decision-making on the project.
Apart from the approaches to feasibility study listed above, some projects
also require for other constraints to be analyzed -

Internal Project Constraints: Technical, Technology, Budget, Resource, etc.

Internal Corporate Constraints: Financial, Marketing, Export, etc.
External Constraints: Logistics, Environment, Laws and Regulations, etc.

Meaning of Capital Budgeting

Capital Budgeting is the process of making investment decision in fixed
assets or capital expenditure. Capital Budgeting is also known as investment,
decision making, planning of capital acquisition, planning and analysis of
capital expenditure etc.

Objectives of Capital Budgeting

The following are the objectives of capital budgeting.

1. To find out the profitable capital expenditure.

2. To know whether the replacement of any existing fixed assets gives more
return than earlier.

3. To decide whether a specified project is to be selected or not.

4. To find out the quantum of finance required for the capital expenditure.

5. To assess the various sources of finance for capital expenditure.

6. To evaluate the merits of each proposal to decide which project is best.

Features of Capital Budgeting

The features of capital budgeting are briefly explained below:

1. Capital budgeting involves the investment of funds currently for getting

benefits in the future.

2. Generally, the future benefits are spread over several years.

3. The long term investment is fixed.

4. The investments made in the project is determining the financial condition

of business organization in future.

5. Each project involves huge amount of funds.

6. Capital expenditure decisions are irreversible.

7. The profitability of the business concern is based on the quantum of

investments made in the project.

Limitations of Capital Budgeting

The following are the limitations of capital budgeting.

1. The economic life of the project and annual cash inflows are only an
estimation. The actual economic life of the project is either increased or
decreased. Likewise, the actual annual cash inflows may be either more or
less than the estimation. Hence, control over capital expenditure can not be
exercised.

2. Capital budgeting process does not take into consideration of various non-
financial aspects of the projects while they play an important role in
successful and profitable implementation of them. Hence, true profitability of
the project cannot be highlighted.

3. It is also not correct to assume that mathematically exact techniques

always produce highly accurate results.

4. All the techniques of capital budgeting presume that various investment

proposals under consideration are mutually exclusive which may not be
practically true in some particular circumstances.

Capital Budgeting

Capital budgeting (or investment appraisal) is the process of determining the

viability to long-term investments on purchase or replacement of property
plant and equipment, new product line or other projects.

Capital budgeting consists of various techniques used by managers such as:

Payback Period
Discounted Payback Period
Net Present Value
Accounting Rate of Return
Internal Rate of Return
Profitability Index
All of the above techniques are based on the comparison of cash inflows and
outflow of a project however they are substantially different in their approach.

A brief introduction to the above methods is given below:

Payback Period measures the time in which the initial cash flow is returned by
the project. Cash flows are not discounted. Lower payback period is preferred.
Net Present Value (NPV) is equal to initial cash outflow less sum of discounted
cash inflows. Higher NPV is preferred and an investment is only viable if its
NPV is positive.
Accounting Rate of Return (ARR) is the profitability of the project calculated as
projected total net income divided by initial or average investment. Net income
is not discounted.
Internal Rate of Return (IRR) is the discount rate at which net present value of
the project becomes zero. Higher IRR should be preferred.
Profitability Index (PI) is the ratio of present value of future cash flows of a
project to initial investment required for the project.