Capital Asset Budgeting
The term "Capital Asset Budgeting" is more accurate, as the absence of "Asset" can make the title misleading. This concept is widely applicable, impacting individuals, regions, countries, and continents. Daily decisions about purchasing or hiring items, and choosing the most cost-effective financing, fall under this domain. It also includes decisions regarding the replacement of liabilities.
Individuals and corporations alike engage in capital asset budgeting, though their methods and benchmarks vary. Corporations employ sophisticated techniques such as:
Payback Period: Time that’s required to recover the initial investment.
Discounted Payback Period: Accounting for the time value of money.
Accounting Rate of Return (ARR): Return on investment based on accounting profits.
Internal Rate of Return (IRR): Discount rate that makes the net present value of cash flows zero.
Net Present Value (NPV): Difference between present value of cash inflows and outflows.
Equivalent Annual Cost/Benefit (EAC/B): Annualized cost or benefit of an investment.
Profitability Index (PI): Ratio of payoff to investment.
In all cases, the principle is that expected benefits should exceed costs. Thus, capital asset budgeting is a critical consideration for making informed financial decisions.
By CA L.Muralidharan and CPA L.Mukundan
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