1) substantial expenditure :
capital budgeting decision involves the investment of substantial amount of funds and is thus it is necessary for a firm to make such decision after a thoughtful consideration, so as to result in profitable use of scarce resources. Hasty and incorrect decisions would not only result in huge losses but would also account for failure of the firm.
2) long time period :
capital budgeting decision has its effect over a long period of time, they affect the future benefits and also the firm and influence the rate and direction of growth of the firm.
3) irreversibility :
most of such decisions are irreversible, once taken, the firm may not been in a position to reverse its impact. This may be due to the reason, that it is difficult to find a buyer for second-hand capital items.
4) complex decision :
capital investment decision involves an assessment of future events, which in fact are difficult to predict, further, it is difficult to estimate in quantitative terms all benefits or costs relating to a particular investment decision.
various types of capital investment decisions
there are various ways to classify capital budgeting decisions, generally they are
classified as :
1) on the basis of the firm's existence :
capital budgeting decisions are taken by both newly incorporated and existing firms. New firms may require to take decision in respect of selection of plant to be installed, while existing firms may require to take decision to meet the requirements of new environment or to face challenges of competition. These decisions may be classified into:
i) replacement and modernisation decisions : replacement and modernisation decisions aims to improve operating efficiency and reduce costs. Usually, plants require replacement due to they been economically dead i.e. no more economic life left or on they becoming technologically outdated. The former decision is of replacement and latter one of modernisation , however, both these decisions are cost reduction decisions.
ii) Expansion decision : existing successful firms may experience growth in demand of the product and may experience shortage or delay in delivery due to inadequate production facilities and thus, would consider proposals to add capacity to existing product lines.
iii) Diversification decisions : these decisions require evaluation proposals to diversify into new product lines, new markets, etc. to reduce risk of failure by dealing in different products or operating in several markets. expansion and diversification decisions are revenue expansion decisions.
2) on the basis of decision situation :
i) mutually exclusive decisions : decisions are said to be mutually exclusive when two or more alternative proposals are such that acceptance of one would exclude the acceptance of the other.
ii) Accept-Reject decisions : the accept-eject decisions occurs when proposals are independent and do not compete with each other. The firm may accept or reject a proposal on the basis of a minimum return on the required investment. All those proposals which have a higher return than certain desired rate of return are accepted and rest rejected.
iii) Contigent decisions :
contigent decisions are dependable proposals, investment in one requires investment in another.