Q.What is capital budgeting decision? Explain briefly the factors affecting capital budgeting decisions.
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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. …
A capital budgeting decision is a long-term investment decision, and several factors influence it; the question asks for its meaning and the factors affecting it. …
Capital budgeting = the long-term investment (fixed asset) decision; factors affecting it include the project's cash flows, the required rate of return, and the investment appraisal criteria.
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- 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.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. …
- CBSE 2025Set 66/4/11 markMCQQ.'KJ Ltd.' is a tile manufacturing company in Udaipur having its own stores in various cities of Rajasthan. Instead of having its own trucks, the company decides to use trucks on lease to transport its tiles to various stores. Identify how the company's decision to lease trucks will affect its capital requirements. (A) Decrease the fixed capital requirements (B) Increase the fixed capital requirements (C) Will not affect the fixed capital requirements (D) Decrease the working capital requirements
›Reveal solutionSolution
Leasing trucks instead of buying them reduces the company’s need for long-term funds tied up in fixed assets, so it decreases fixed capital requirements.
When a business like KJ Ltd. decides to lease trucks rather than purchase them outright, the immediate effect is on its fixed capital — the money invested in long-term assets such as land, buildings, machinery, and vehicles. Fixed capital is the foundation of production capacity; it stays with the company for years and is not easily converted into cash. Buying a fleet of trucks would require a large, one-time outflow of funds, locking up capital that could otherwise be used for day-to-day operations or expansion.
By choosing to lease, KJ Ltd. avoids that heavy upfront investment. The leasing company owns the trucks; KJ Ltd. simply pays a periodic rental fee for their use. This means the company does not have to raise or set aside a big sum for purchasing vehicles. The fixed capital requirement — the total long-term investment in assets — therefore goes down. The company can still transport its tiles to stores across Rajasthan, but without the burden of owning depreciating assets.
NoteLeasing is a form of operating lease in accounting terms. It is treated as a rental expense, not as an asset purchase, so it does not appear on the balance sheet as fixed capital.
Now, what about working capital? Working capital is the money needed for short-term operations — raw materials, salaries, rent, and so on. Leasing trucks does not directly change the volume of tiles produced or sold, nor does it alter the cash cycle of buying raw materials and collecting payments from stores. So the decision to lease does not affect working capital requirements. The correct answer is therefore about fixed capital, not working capital.
ImportantA common mistake is to think that leasing reduces working capital because it saves cash. But saving cash by avoiding a big purchase does not change the requirement for working capital — it only frees up cash that can be used elsewhere. The requirement itself depends on production and sales volume, not on how you finance your fixed assets.
Let’s look at the options one by one: …
- CBSE 2025Set ANNUAL1 markMCQQ.Fixed capital is required (A) For payment of routine expenses (B) For purchase of land (C) For purchase of stock (D) For payment to creditors
›Reveal solutionSolution
Fixed capital funds the acquisition of long-term fixed assets such as land, building and machinery. Purchase of land is therefore the correct use; the other options are met from working capital.
- (A) Payment of routine expenses — working-capital use. ✗
- (B) Purchase of land — a fixed asset held long-term, financed by fixed capital. ✓ …
- CBSE 2024Set MARCH1 markQ.Give the full form of RoI.
›Reveal solutionSolution
RoI is the full form Return on Investment — a measure of the profit or return earned in relation to the amount of capital invested.
In the Kerala Plus Two (DHSE) Financial Management topic, Return on Investment (RoI) is used in the investment/capital-budgeting decision to compare the earnings generated by a project against the funds committed to it. A higher RoI means the …
- CBSE 2024Set MARCH1 markQ.Manyatha Company wants to construct a new building for ₹ 50 Lakh. Identify the type of decision involved in financial management.
›Reveal solutionSolution
Investment decision (capital budgeting) - long-term investment of funds in a fixed asset.
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- CBSE 2024Set ANNUAL1 markMCQQ.Capital budgeting is the other name for(a) investing decision(b) financing decision(c) dividend decision(d) working capital decision
›Reveal solutionSolution
Capital budgeting is simply another name for the Investment Decision — the financial-management decision about which long-term/fixed assets or projects to put the firm's money into.
Financial management recognises three broad decisions: the Investment Decision (where to invest the firm's funds — long term in fixed assets, or short term in working capital), the Financing Decision (how much to raise through owners' funds vs. borrowed funds, i.e. capital structure), and the Dividend Decision (how much profit to distribute to shareholders vs. retain in the business). Capital budgeting specifically deals with long-term investment decisions — evaluating and selecting proposals for acquiring fixed assets or starting new projects, usually involving large sums of money, long-term commitment and higher risk, and judged using techniques like payback period, average rate of return, or net present value. Because this is the long-t …
- CBSE 2023Set MARCH1 markQ.Fixed capital is invested in ____________ (Choose from: SEBI, Coordination, Fixed Assets, Job rotation, Budget)
›Reveal solutionSolution
The blank is filled by 'Fixed Assets'.
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- CBSE 2023Set ANNUAL1 markMCQQ.Decision of allocation of funds to long term assets is ________ .(a) Capital budgeting(b) Working Capital decision(c) Capitalisation(d) Wealth maximisation(a) Capital budgeting(b) Working Capital decision(c) Capitalisation(d) Wealth maximisation
›Reveal solutionSolution
Allocating funds to long-term assets = Capital Budgeting — Option (A).
In financial management, decisions are broadly grouped into three: the Investment decision, the Financing decision, and the Dividend decision. The Investment decision, when it concerns long-term assets (fixed assets such as land, plant, machinery, or a new project), is specifically called the Capital Budgeting decision — it decides how the firm's long-term funds will be invested in projects/assets expected to yield returns over several years.
…
- CBSE 2023Set ANNUAL1 markMCQQ.Capital budgeting is the other name of(a) investing decision(b) financing decision(c) dividend decision(d) working capital decision
›Reveal solutionSolution
Capital budgeting is another name for the investment decision.
Financial management involves three core decisions: the investment decision (where to deploy the firm's funds, long term or short term), the financing decision (what mix of debt and equity to raise those funds from), and the dividend decision (how much profit to distribute to shareholders versus retain). Capital budgeting specifically deals with long-term investment — evaluating and selecting projects such as a new factory, machinery or expansion plan — which places it squarely under the investment decision. …
- CBSE 2020Set 66/C/11 markQ.Organisations which choose to diversify their operations require __________ fixed capital. (more/less)
›Reveal solutionSolution
Diversification requires new plants, equipment and infrastructure to support the added product lines — pushing fixed-capital requirements upward.
Fixed capital refers to funds invested in long-term, fixed assets such as land, buildings, plant and machinery — the assets that give a business its basic production capacity. When an organisation chooses to diversify — that is, expand into new products, markets or lines of business beyond its current operations — it typically needs to set up additional manufacturing facilities, install new machinery, and build the physical infrastructure necessary to support those new activiti …
- CBSE 2020Set MARCH1 markMCQQ.Decisions of investment means. . . . .(a) Capital cost(b) Capital budgeting(c) Capital structure(d) Ploughing back of profit
›Reveal solutionSolution
The investment decision = capital budgeting. Correct option: (b) Capital budgeting.
In financial management, the investment decision means deciding where and how much to invest in long-term assets (plant, machinery, new projects, expansion). Evaluating and choosing such long-term investment proposals is called capital budgeting.
- (a) Capital cost is the cost of raising funds, not the investment decision itself. …
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