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Importance

Capital budgeting decisions are of paramount importance in financial decision making. In the first place, .such decisions affect the profitability of a firm. They also have a bearing on the competitive position of the enterprise mainly because of the fact that  relate to fixed assets. The fixed assets represent, in’ a sense, the true earning assets of the firm, Tile enable the firm to generate finished goods that can ultimately be sold for profit. The current assets are not generally earning assets. Rather. they provide a buffer that allows the Finns to make sales and extend credit. True, current assets are important to operations, but without fixed assets to generate finished products that can be converted into current assets, the firm would not be able to operate. Further, they are ‘strategic’ investment decisions as against tactical which involve a relatively small amount of funds. Therefore, such capital investment decisions may result in a major departure from what the company has been doing in the past. Acceptance of a strategic investment will involve a Significant change in the company’s expected profits and in the risks to which these profits will be subject. These changes .are likely to lead stockholders and creditors to revise their evaluation of the company. Thus, capital budgeting decisions determine me future destiny of me Coltrane opportune investment decision can yield spectacular returns. On me other hand, an Andalusian . incorrect decision can endanger the very survival even of the large firms. A few’wrong decisions and the firm may he forced into bankruptcy. Secondly, a capital expenditure decision has us effect over a long meantime and inevitably affects the company’s future cost structure. To illustrate, if ;I particular plant has been purchased by a company to start a new product, the company commits itself to a sizable amount of fixed Cosmos  in terms of labor. supervisors’ salary, insurance, rent Qf building, and so on. If the investment turns out 10 be unsuccessful in future or yields less profit than anticipated. the firm will have to bear the burden’ of.fixed LCM’ unless it writes off the investment completely. In short, future costs, break-even point. sales and profits will all be determined ht the selection of assets. Thirdly, individualistically decisions, once made, are not easily reversible without much maniacal loss to the firm because there may be no marker for second-hand plant and equipment and their conversion or other Rise may not he financially viable: Finally, capital vestment involves costs and the majority of the firms have scarce capital resources. This underlines the need for thoughtful, wise and correct investment decisions, as an incorrect decision would not only result in losses hut also prevent the firm from earning profits from other investments which could not he undertaken for want of funds.

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