Read the following passage and answer the question.
Neeru, the finance manager, and Mani, the managing director of ABCD Ltd., were discussing how to raise funds for modernising their existing plant. Neeru suggested using equity, pointing out that the Sensex has risen by 6,000 points in the last 4 years. However, Mani wanted to choose debt as the source of finance. He feared that a fresh issue of equity shares might make the company an easy target for a takeover bid. The company has high fixed operating costs, such as building rent, insurance premium and salaries.
Modernising the existing plant is which type of decision?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Capital budgeting decision
Option (1) Working capital decision — Incorrect. Working capital decisions are short-term. They deal with the levels of cash, inventory and receivables. A plant is a fixed asset.
Option (2) Capital budgeting decision — Correct. A capital budgeting decision is a long-term investment decision. Spending on the modernisation of fixed assets is part of it. ABCD’s plant will serve for many years, so the funds are committed for the long term.
Option (3) Dividend decision — Incorrect. This decision is about how much profit to pay to shareholders and how much to keep. Modernising a plant is a use of funds.
Option (4) Financing decision — Incorrect. Neeru and Mani are debating the source, equity or debt, and that part is a financing decision. But modernising the plant itself is the use of the money.
NCERT (2026-27 Edition): “Management of Fixed Capital Fixed capital refers to investment in long-term assets. Management of fixed capital involves allocation of 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. It must be financed through long-term sources of capital such as equity or preference shares, debentures, long-term loans and retained earnings of the business. Fixed Assets should never be financed through short-term sources. Investment in these assets would also include expenditure on acquisition, expansion, modernisation and their replacement. …” |