Deciding if it is time to buy a new car can certainly be influenced by the amount of money that will be tied up for the next several years. For the average person, it could be a very precarious decision, especially with the volatility of the economy. There are many factors to consider when making major purchases such as time, money, resale value, and overall necessity. Whether it is a personal budget or a budget for a multi-million dollar company, trying to predict what will happen in the future will always have it’s risks. However, it is an important aspect of a company’s survival and the overall success in the future.
As stated in Corporate Finance by Ehrhardt and Brigham, capital implies long-term assets that are utilized in production and a budget is a plan that outlines anticipated expenditures during a coming period (p 381). So, when the two words are combined to imply one definition, the term capital budget is a synopsis of planned investments of assets that will remain for more than a year. Additionally, capital budgeting is the process as a whole of analyzing projects and determining which ones to acknowledge and then incorporate in the capital budget (Ehrhardt & Brigham, 2011, p. 381).
The capital budgeting practice includes forecasting and identifying cash flows, performing scenario and sensitivity analysis, and applying capital budgeting tools (Kwok & Rabe, 2010). This process is essentially where the financial potential for a possible investment or multiple investments is evaluated. In the chance that there are several potential opportunities for investment, each investment must be analyzed and compared against the other possibilities in order to figure out which opportunity has the potential for the greatest yield.
As an example, MP3 players are quite popular. However, there are several substantial failures in the market and the Microsoft Zune is one of them. The capital budgeting for the development, advertising, and ultimate production of the product certainly never accounted for it’s highly impressive competitor, the iPod (The 10 Biggest, 2009). Even though the Zune came into the market much later, it’s failure would certainly make one question the amount of research that was done because at that time Apple already had a huge position in the market.
The precise nature of a corporation’s capital investments decides what production volume the corporation is competent to handle, how financially efficient and profitable it will be, and even how it determines its pricing strategies. The cost efficiency and operational efficiency that the corporation as a whole, experiences are essentially influenced by its capital budgeting decisions. In general, the capital budgeting process can have an impact on if a company can acquire new equipment, replace equipment, expand their campus, develop new products and perform necessary research for new products (Sullivan & Sheffrin, 2005, p. 375). In order to do any...