Identify the factors affecting Capital Budgeting decision :

(A) Cash flows of the project

(B) Rate of return of the project

(C) Stability of Dividend

(D) State of Capital Market

(E) Investment Criteria involved

Choose the correct answer from the options given below :

(A), (B) and (E) only

The correct answer is option (2)- (A), (B) and (E) only.

Fixed capital refers to investment in long-term assets. Management of fixed capital involves the allocation of a firm’s capital to different projects or assets with long-term implications for the business. These decisions are called investment decisions or capital budgeting decisions and affect the growth, profitability, and risk of the business in the long run. These long-term assets last for more than one year. A number of projects are often available to a business to invest in. But each project has to be evaluated carefully and, depending upon the returns, a particular project is either selected or rejected. If there is only one project, its viability in terms of the rate of return, viz., investment and its comparability with the industry’s average is seen. There are certain factors which affect capital budgeting decisions. These factors are as follows-

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.

B) The rate of return: The most important criterion is the rate of return of the project. These calculations are based on the expected returns from each proposal and the assessment of the risk involved. Suppose, there are two projects, A and B (with the same risk involved), with a rate of return of 10 percent and 12 percent, respectively, then under normal circumstances, project B should be selected.

E) The investment criteria involved: The decision to invest in a particular project involves a number of calculations regarding the amount of investment, interest rate, cash flows and rate of return. There are different techniques to evaluate investment proposals which are known as capital budgeting techniques. These techniques are applied to each proposal before selecting a particular project.

OTHER OPTIONS

• (C) Stability of Dividends- Affect dividend decision. Companies generally follow a policy of stabilising dividend per share. The increase in dividends is generally made when there is confidence that their earning potential has gone up and not just the earnings of the current year. In other words, dividend per share is not altered if the change in earnings is small or seen to be temporary in nature.

• (D) State of Capital Market- Affect financing decision. Health of the capital market may also affect the choice of source of fund. During the period when stock market is rising, more people invest in equity. However, depressed capital market may make issue of equity shares difficult for any company.