Before choosing among three new projects, the finance manager of Theta Ltd. applies different techniques of evaluating investment proposals to each one. These use calculations of the amount of investment, interest rate, cash flows and rate of return. Which factor affecting the capital budgeting decision is shown here?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → The investment criteria involved
Option (1) The rate of return — Incorrect. The rate of return is the most important criterion. Of two projects with the same risk, the one with the higher return is normally chosen. Here the manager runs several calculations through set techniques.
Option (2) Cash flows of the project — Incorrect. Cash flows are the series of cash receipts and payments over the life of an investment. In this case they are only one input to the calculations.
Option (3) The investment criteria involved — Correct. Choosing a project calls for calculations on the amount of investment, interest rate, cash flows and rate of return. The methods for this are called capital budgeting techniques. They are applied to each proposal before one is selected, as Theta Ltd. is doing.
Option (4) Floatation costs — Incorrect. Floatation cost is the cost of raising funds, such as the expense of a public issue. It is a factor in the financing decision.
NCERT (2026-27 Edition): “Factors affecting Capital Budgeting Decision … (a) Cash flows of the project: When a company takes an investment decision involving huge amount it expects to generate some cash flows over a period. These cash flows are in the form of a series of cash receipts and payments over the life of an investment. The amount of these cash flows should be carefully analysed before considering a capital budgeting decision. |