Question 3

“A capital budgeting decision is capable of changing the financial fortunes of a business.” Do you agree? Give reasons for your answer?


Yes, a capital budgeting decision is capable of changing the financial fortunes of a business. Investment decision involves careful selection of assets in which funds are to be invested. Decisions relating to investment in fixed assets are known as capital budgeting decision, whereas, those concerning investment in current assets are called working capital decisions.

A business needs to invest funds for setting up new business, for expansion and modernization. Investment decision is taken after careful scrutiny of available alternatives in terms of costs involved and expected return.

These decisions are very crucial for any business. Earning capacity of the fixed assets of a firm, profitability and competitiveness, all are affected by the capital budgeting decisions. Moreover, these decisions normally involve huge amount of investment and are irreversible, except at a huge cost.

Following are the factors that highlight the importance of capital budgeting decisions.

  1. These are long-term decisions and can be reserved only at huge costs.
  2. These generally involve commitment of huge funds.
  3. These have a significant effect on the profitability and future of the business.

Thus, once these decisions are taken, it is impossible for a firm to undo these decisions and certainly a bad capital budgeting decision normally has the capacity to severely damage the financial fortune of a business.

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