Which of the following factors affects capital budgeting decisions?

(A) Cash flows of the project
(B) The investment criteria involved
(C) Stock market sentiments
(D) Level of competition

Choose the correct answer from the options given below:

(A) and (B) only

The correct answer is Option (2) → (A) and (B) 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 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

• (D) Level of Competition- Affect working capital decision: Higher level of competitiveness may necessitate larger stocks of finished goods to meet urgent orders from customers. This increases the working capital requirement. Competition may also force the firm to extend liberal credit terms discussed earlier.

• (C) Stock Market Reaction- Affect dividend decision : Investors, in general, view an increase in dividend as a good news and stock prices react positively to it. Similarly, a decrease in dividend may have a negative impact on the share prices in the stock market. Thus, the possible impact of dividend policy on the equity share price is one of the important factors considered by the management while taking a decision about it.