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Disadvantages Of Capital Budgeting

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Introduction
Capital Budgeting is a process that allows businesses to assess whether their investment decisions like purchasing a new plant, constructing a new building, or engaging in a new venture is profitable enough to pursue. (Investopedia. 2015) When making crucial investment decisions, capital budgeting gives businesses a more informed way of deciding. This is because investment decisions are weighed in terms of the cash flows over the duration of the new venture or investment. This way, a company can have more visibility in terms of monitoring its cash flows for every period. Consequently, businesses can make an initial evaluation of pushing through a certain project or not. This is what makes capital budgeting very useful since companies …show more content…

This is one of the most essential components in budgeting. Without the forecasted cash flows of the business investment or venture to be assessed, capital budgeting is not possible. And to arrive with reasonable cash flow forecasts, the business should be able to identify the level of sales or demand for the business decision. To achieve this, the business will have to conduct an initial market study for their planned venture. Aside from the sales level, the business should also be able to identify the level of pricing that they will use. Setting the price too low may attract a lot of customers but may also be disadvantageous to the profit of the business. The business may also set the price too high to get a better profit figure but will also consequently risk lower demand for their product. Aside from the sales level and the pricing, to be able to properly use capital budgeting, businesses should also know the cost of the investment that they will potentially pursue. Moreover, the business should also know whether such an investment will have a salvage value or not at the end of its planned duration of use. All of these data should be available to the company so that a business can properly use capital budgeting …show more content…

(Investopedia. 2015) The logic of this approach in capital budgeting is to arrive at the overall project value at the end of the project duration. This method also evaluates the project profitability not only by using the cash flows of the project but also the value of the project when considering interest rates, time value of money, inflation, and all other factors that may lead to the change of the value of a single dollar. (AccountingInformationManagement.Org. 2015) NPV is calculated using the following

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