Q.Explain any three factors affecting capital budgeting decision of a company.
🔒You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.
🔒 Start your 14-day free trial to unlock the full solution →Part (a)Concept understanding — Capital Budgeting Impact
Capital Budgeting Impact
Imagine you're deciding whether to buy a new laptop for college. You'll spend ₹60,000 today, but you expect it to help you earn ₹10,000 extra per year through freelancing for the next 4 years. Is that a good decision? You're not just comparing ₹60,000 with ₹40,000 — because money today is worth more than money tomorrow, and you have to account for risk, alternatives, and timing.
That's the core of capital budgeting: evaluating whether a long-term investment (buying a machine, building a factory, launching a product) is worth the money you put in today.
The Intuition
Capital budgeting answers one question: "Will this investment create more value than it costs?"
But it's not simple arithmetic. Three things make it tricky:
- Time value of money — ₹1 lakh today is not the same as ₹1 lakh five years from now. You could invest that ₹1 lakh today and earn interest.
- Uncertainty — future cash flows are guesses, not guarantees.
- Opportunity cost — if you put money into Project A, you cannot put it into Project B.
So capital budgeting techniques adjust future cash flows for time and risk, then compare them to the initial cost.
The Precise Statement
Capital budgeting is the process of evaluating and selecting long-term investments by comparing the present value of expected future cash inflows against the initial cash outflow, using techniques like Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index.
The impact of capital budgeting is the difference between the value the investment creates and what it costs — measured in today's money.
The Key Techniques (at a glance)
| Technique | What it tells you | Decision rule |
|---|---|---|
| Net Present Value (NPV) | Total value created in today's rupees | Accept if NPV > 0 |
| Internal Rate of Return (IRR) | The rate of return the project earns | Accept if IRR > cost of capital |
| Payback Period | How fast you recover your investment | Accept if within target period |
| Profitability Index | Value created per rupee invested | Accept if PI > 1 |
Why It Matters
A bad capital budgeting decision can sink a company. If you overestimate future cash flows, you might build a factory that never earns back its cost. If you underestimate, you might reject a project that would have been profitable. …
Part (b)Concept understanding — Financial Planning Objectives
Financial Planning Objectives – First Encounter
Imagine you've just started earning. You have some money coming in each month, and you also have expenses – rent, food, maybe a phone bill. At the end of the month, whatever is left is yours to decide what to do with. You could spend it all on a new phone, or you could put some aside for a bigger goal – a bike next year, or a house in ten years.
That act of deciding what to do with your money is the seed of financial planning. But planning without a clear purpose is just guessing. That's where objectives come in.
The Intuition: Why "Objectives" Matter
Think of financial planning like a road trip. You wouldn't just start driving. You'd ask: Where am I going? That destination is your objective. Without it, you might run out of fuel halfway, take a wrong turn, or end up somewhere you never wanted to be.
In personal finance, your objectives are the destinations for your money. They give every rupee you save or invest a job. A rupee without a job is just a rupee that gets spent on nothing in particular. A rupee with a job – "buy a house in 5 years" or "retire at 60" – becomes a tool.
The Precise Statement
Financial Planning Objectives are the specific, measurable, time-bound financial goals that an individual or household sets to achieve desired life outcomes through the systematic management of income, expenses, savings, and investments.
In simpler terms: they are the what and when of your money decisions.
The Core Objectives (What Every Student Must Know)
There are four fundamental objectives that every financial plan aims to satisfy. Think of them as the four pillars holding up your financial life.
| Objective | What It Means | Example |
|---|---|---|
| Adequacy | Having enough money when you need it | ₹50,000 saved for an emergency medical bill |
| Security | Protecting against unexpected losses | Having health insurance so one accident doesn't wipe out your savings |
| Growth | Making your money increase over time | Investing ₹10,000 in a mutual fund that grows to ₹15,000 in 3 years |
| Liquidity | Being able to access cash quickly when needed | Keeping ₹5,000 in a savings account, not locked in a fixed deposit |
The Hierarchy of Objectives (How They Stack)
Not all objectives are equal. They form a pyramid, just like Maslow's hierarchy of needs.
-
Survival & Protection (Bottom layer) – This is non-negotiable. You need enough money for food, rent, and basic bills. You also need insurance so a medical emergency doesn't destroy you. Without this, nothing else matters.
-
Emergency Fund (Second layer) – A cash reserve (typically 3–6 months of expenses) for job loss or sudden large expenses. This is your financial shock absorber.
-
Short-term Goals (Third layer) – Things you want in 1–3 years: a new laptop, a vacation, a down payment for a car. These need safe, liquid investments.
-
Long-term Goals (Top layer) – Things 5+ years away: buying a house, children's education, retirement. These can tolerate more risk for higher growth.
A common mistake students make is jumping to growth (investing in stocks) before securing adequacy and security. If you invest your emergency fund in the stock market and the market crashes right when you lose your job, you lose both your money and your safety net. Always build from the bottom up.
The SMART Test for Any Objective
A good financial objective must pass this test:
- Specific – "Save for a bike" is vague. "Save ₹1,00,000 for a bike" is specific.
- Measurable – You must be able to track progress. "I need ₹8,333 per month for 12 months."
- Achievable – Realistic given your income. Don't aim to save ₹50,000/month if you earn ₹30,000. …
Part (a)
Three factors affecting the capital budgeting (investment) decision:
- Cash flows of the project — the series of cash receipts and payments expected over the life of the proposal must be carefully estimated, as they decide the project's worth.
- The rate of return — the expected return from each proposal, compared with its risk, guides which project is selected (the one giving the higher return for a given risk is preferred). …
Part (a): Capital budgeting decisions depend on the project's cash flows, the expected rate of return, and the investment criteria used. Part (b): Financial planning aims to ensure funds are available when needed and to avoid raising funds unnecessarily.
Part (a)
A capital budgeting (investment) decision relates to how the firm's funds are invested in long-term (fixed) assets. Three factors that affect it are:
-
Cash flows of the project. When a company takes up an investment proposal, it expects a series of cash inflows and requires cash outflows over the life of the project. These cash flows must be carefully estimated because they form the basis for judging the worth of the proposal.
-
The rate of return. The most important criterion is the expected rate of return from each proposal, considered along with the risk involved. Between two proposals of the same risk, the one giving the higher rate of return will be preferred. …
Showing the 12 most recent of 49 on this concept.
- CBSE 2026Set ANNUAL1 markMCQQ.Capital budgeting decisions are often A) Short term B) Long term C) Very short term D) Cannot be determined
›Reveal solutionSolution
Capital budgeting deals with long-term investment in fixed assets, so the answer is B) Long term.
In the Class-12 Business Studies syllabus, capital budgeting or investment decision refers to how a firm allocates its capital among long-term projects — buying machinery, setting up a plant, launching a new product line. These decisions:
- Affect the earning capacity of the business for many years into the future.
- Involve large amounts of money and high risk. …
- CBSE 2026Set ANNUAL1 markMCQQ.Increasing the wealth of shareholders is the main objective of which of the following? A) Marketing management B) Production management C) Human resource management D) Financial management
›Reveal solutionSolution
Increasing shareholders' wealth is the main objective of financial management, so the answer is D) Financial management.
Financial management aims at the wealth maximisation (value maximisation) of the firm — that is, increasing the market price of its shares, which represents the wealth of the equity shareholders. The other functional areas have different primary objectives:
- Marketing management (A) — satisfying customers and achieving sales. …
- CBSE 2026Set ANNUAL1 markMCQQ.The main objective of financial management is(a) Profit maximisation(b) Wealth maximisation(c) Sales maximisation(d) Cost minimisation
›Reveal solutionSolution
The main objective of financial management is wealth maximisation (maximising the market value of the firm's equity shares).
Financial management aims to ensure the right amount of finance is raised at the lowest cost and used in the most profitable way so as to maximise the wealth of shareholders, reflected in the market price of equity shares. This objective is preferred over simple pro …
- CBSE 2026Set ANNUAL1 markQ.Write answer in one word/sentence: In which heading formed the financial policies?
›Reveal solutionSolution
Financial policies are formed under financial planning.
Financial planning is the process of estimating the funds a business needs and deciding how to raise and use them. The firm's financial policies — relating to raising capital, its investment and the distribution of profits — are framed as part of financial planning, within the overall function of fina …
- CBSE 2026Set ANNUAL1 markMCQQ.What is the primary objective of financial management?(a) Maximisation of profit(b) Maximise growth in shareholders wealth(c) Payment to creditors(d) Increase in fixed assets of business(a) Maximisation of profit(b) Maximise growth in shareholders wealth(c) Payment to creditors(d) Increase in fixed assets of business
›Reveal solutionSolution
The primary objective of financial management is wealth maximisation — maximising the market value of equity shares / shareholders' wealth — not mere profit maximisation.
Profit maximisation was the traditional objective of financial management, but it has serious limitations: it ignores the time value of money, ignores risk, and can be manipulated by accounting choices, and it says nothing about how benefits are distributed over time. Modern financial management therefore adopts wealth maximisation (shareholder-value maximisation) as the primary objective — every financial decision (investment, financing, dividend) is judged by whether it increases the market value of the shareholders' investment in the firm, taking into account both the s …
- CBSE 2026Set ANNUAL1 markQ.What is meant by Financial Management?
›Reveal solutionSolution
Financial Management means planning, organising, directing and controlling an enterprise's funds so that the organisation's financial objectives are efficiently achieved.
Meaning: Financial Management refers to that specialised area of management activity concerned with the application of general management principles to the acquisition, financing and management of an enterprise's funds. It is essentially about taking the three core financial decisions — investment, financing and dividend — in a manner that maximises shareholders' wealth while ensuring the firm has adequate, timely and cost-effective funds to operate.
…
- CBSE 2026Set ANNUAL1 markQ.Linthoi is holding 100 shares of Imphal Urban Ltd. The market price of each share has increased from Rs. 550 to Rs. 600. Compute the amount of increase in her wealth as a shareholder of the company.
›Reveal solutionSolution
Increase in Linthoi's wealth = (new price − old price) × number of shares = (600 − 550) × 100 = Rs. 5,000.
Working
- Number of shares held = 100
- Old market price per share = Rs. 550
- New market price per share = Rs. 600
- Increase in price per share = Rs. 600 − Rs. 550 = Rs. 50
- Increase in Linthoi's wealth = 100 shares × Rs. 50 = Rs. 5,000 …
- CBSE 2026Set ANNUAL1 markMCQQ.What is the main objective of financial management?(a) Profit maximization(b) Risk minimization(c) Wealth maximization(d) Dividend decision
›Reveal solutionSolution
Wealth maximisation (maximising shareholders' wealth) is the accepted main objective of modern financial management.
Traditionally, profit maximisation was seen as the objective of financial management, but it has limitations — it ignores the time value of money, risk, and quality of returns, and can encourage short-term thinking at the cost of long-term sustainability.
Modern financial management instead adopts wealth maximisation as its guiding objective — this means maximising the market value of the firm's equity shares, which captures:
- current and future profitability,
- risk associated with the investment,
- the time value of money (benefits received sooner are worth more). …
- CBSE 2026Set ANNUAL1 markMCQQ.The number of stock exchanges in India is(a) 20(b) 21(c) 22(d) 25
›Reveal solutionSolution
The textbook figure used for this (now out-of-syllabus) question is 21 recognised stock exchanges in India.
Syllabus note: Stock exchanges, and the 'Financial Markets' chapter they belonged to, have been removed from the current NCERT/CBSE-aligned Class 12 Business Studies syllabus — the closest current topic is Financial Management. This question still appears on this paper, so it is answered here for completeness, honestly flagged as syllabus-adjacent rather than core current-syllabus content.
A stock exchange is an organised market where existing (already-issued) securities like shares and debentures are bought and sold. The number of SEBI-recognised stock exchanges in India has changed considerably over time:
- In the pre-2012 period, India had over 20 regional stock exchanges besides the two major national exchanges (BSE and NSE).
- The commonly quoted figure in NCERT-era Financial Markets chapter/exam material was 21 recognised stock exchanges. …
- CBSE 2026Set ANNUAL1 markMCQQ.The process of estimating fund requirements of a business and specifying the sources of funds is called(a) capital structure(b) financial planning(c) financial management(d) capital budgeting
›Reveal solutionSolution
Financial planning is the process of estimating fund requirements and specifying the sources of those funds.
Financial planning involves deciding in advance the financial activities necessary to ensure that the right amount of funds are available at the right time, neither too much (idle funds) nor too little (shortage). It has two key parts:
- Estimating the quantum of funds required by the business.
- Determining the pattern/sources of financing (equity, debt, retained earnings, etc.).
This differs from:
- Capital structure — the actual proportion/mix of debt and equity used.
- Financial management — the broader function covering investment, financing and dividend decisions (financial planning is a sub-part of this). …
- CBSE 2026Set ANNUAL1 markMCQQ.Which of the following is a regulatory function of the Securities and Exchange Board of India?(a) Registration of brokers and sub-brokers and other players in the market(b) Training of intermediaries of the securities market(c) Promotion of fair practices and code of conduct in securities market(d) Conduct research and publishing information useful to all market participants
›Reveal solutionSolution
SEBI's regulatory functions include registering and licensing market intermediaries like brokers and sub-brokers.
Syllabus note: SEBI and its functions were traditionally taught in the 'Financial Markets' chapter, now removed from the current NCERT/CBSE-aligned Business Studies syllabus (closest current chapter is Financial Management). Answered here for completeness since the paper includes it.
SEBI (Securities and Exchange Board of India) performs three broad types of functions:
- Regulatory functions — registration of stock brokers, sub-brokers, merchant bankers and other intermediaries; regulation of stock exchanges; regulation of takeovers.
- Developmental functions — training of intermediaries; conducting research and publishing useful information to market participants; promoting fair practices and a code of conduct. …
- CBSE 2026Set ANNUAL1 markMCQQ.The financial decision involved in replacing an old fixed asset with a new one is known as ....................(a) Working capital decision(b) Capital budgeting decision(c) Financing decision(d) Dividend Decision
›Reveal solutionSolution
The decision is a Capital budgeting decision.
Financial management involves three broad types of decisions:
- Capital budgeting (investment) decision — relates to how the firm's funds are invested in long-term/fixed assets, e.g., buying new machinery, expanding capacity, or replacing an old fixed asset with a new one; it involves large funds, is long-term, and is largely irreversible.
- Financing decision — relates to how much funds should be raised and from which source (debt vs. equity).
- Working capital (dividend-adjacent) decision — relates to managing current assets and current liabilities for day-to-day operations. …
🎓Unlock everything free for 14 days
- ✓Full step-by-step solutions
- ✓Concept-first explanations
- ✓Methods, shortcuts & mistakes
- ✓PYQ mapping + timed mock tests
Full access for 14 days. No credit card required.