Kanav, after passing out of college with specialization in renewable energy, was determined to start a solar p

Question 21 of 37

Q. Kanav, after passing out of college with specialization in renewable energy, was determined to start a solar power plant. The venture required heavy investment in plant and machinery and less on manual labour. Kanav invested in the latest solar panel technology and infrastructure and purchased the latest solar panels, inverters and battery storage systems. Despite the high risk and substantial investment, Kanav's business had good expansion possibilities. The world was increasingly moving towards clean energy solutions, and there was a growing demand for sustainable power sources. So, Kanav decided to create a higher capacity to meet the anticipated demand quickly. This entailed further investment in fixed assets which Kanav was able to arrange. As the years passed, the solar power plant did very well and played a pivotal role in the city's transition towards a greener and more sustainable future. Identify and explain the two factors affecting the fixed capital requirements discussed in the above case.

Punjab PsebCBSE Class XII Board 2024Subjective· 3mImportance★★★★★

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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. …

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The two factors affecting fixed capital requirements in this case are Choice of technique (a capital-intensive technique needing heavy investment in plant and machinery) and Growth prospects (higher expected growth needing further investment in fixed assets).

Fixed capital refers to the funds invested in long-term assets such as land, buildings, plant and machinery. In CBSE Class 12 Business Studies (Financial Management), several factors decide how much fixed capital a business needs; Kanav's solar power plant clearly illustrates two of them.

Choice of technique

A firm may adopt a capital-intensive technique (relying mainly on machinery) or a labour-intensive technique (relying mainly on manual labour). A capital-intensive business needs far greater investment in fixed assets.
- From the case: "The venture required heavy investment in plant and machinery and less on manual labour," and Kanav "invested in the latest solar panel technology and infrastructure and purchased the latest solar panels, inverters and battery storage systems." This dependence on machinery rather than labour is the choice of a capital-intensive technique, which raises the fixed capital requirement.
Growth prospects

A business that expects high growth must invest more in fixed assets in advance to create the capacity needed to meet future demand. …

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