"Capital Budgeting is important not only because of the high investment cost of capital projects, but also due to their irreversible nature, long-term commitment and impact on profitability." Explain this statement and d

Answer 6A(ii) Capital budgeting is important because projects like new plants or machinery involve high investment costs, if a wrong decision is taken it will be very expensive. These projects also have an irreversible nature, once started they cannot easily be reversed without losses. They require a permanent commitment, locking the business into a long-term path, and their outcomes have long-run effects on profitability, shaping growth and competitiveness for years. Capital Budgeting is important because of the following reasons: Capital budgeting highlights the possibilities of expansion of production facilities to cover up the additional demand shown in projected sales budget. It shows comparative position of available different alternative assets for the replacement of old or obsolete assets. It helps in long-term planning and formulation of policy. Appropriate time of purchase of assets and of improvement in the quality of purchased assets is known by proper capital budgeting. It helps in estimating the total requirement of capital with its break-up over the years. This analysis helps in timely arrangement of funds required for the purpose. It also helps in planning capital structure because the net surplus of a project depends on the cost of capital, which in its turn depends upon the capital structure of the firm. Capital budgeting provides necessary information for cash forecasts and budget. It helps in preparing a sound policy for depreciation and replacement of assets. The firm can plan its dividend policy, which is in keeping with profit and wealth maximization objective of the firm as well as the necessary internal resource generation for further business expansion. It can prove beneficial for considering the methods and measures to minimize cost. It can thus help in planning modernization of existing production facilities. It highlights the desirability of replacement of men by machines.