Some factors combine to make capital budget decisions that may be the most important financial managers and their staff must do. There are a large number of variables that must be considered, although many can be defined as clear, due to their probability of occurrence. However, if the company faces bankruptcy, and if their market judgment is huge and incorrect, the cost of failure is enormous. This report then focuses on assessing the major risks affecting capital budgeting decisions and how this information can help in the analysis of fixed asset investment
First, as the results of capital budgeting decisions have had an effect on many years , The company will lose some of its flexibility. For example, buying assets with ten years of economic life locks the company for ten years. In addition, the decision to purchase an asset that is expected to last ten years requires a ten-year sales forecast, as asset expansion is largely related to expected future sales. If the company invests too much in the assets, it will generate unnecessary high depreciation and other expenses. On the other hand, if it is not enough to pay for fixed assets, two problems may arise. "First, their equipment may not be enough to achieve the lowest cost of production; the second, if its capacity is insufficient, it may lose part of its competitor's market share, and re-acquisition of customers will involve significant sales costs and prices fall, . If the company predicts its demand for capital assets in advance, it will have the opportunity to buy and install assets before it is needed. Unfortunately, many companies do not order capital goods until the existing assets are close to full capacity. If sales increase due to general market demand, then all companies in the industry will tend to order capital goods at about the same time. This leads to "backlogs, machine waiting time is long and prices are rising". Companies that anticipate their needs and buy capital assets during periods of inactivity can avoid these problems. A capital budget usually involves a large amount of expenditure, and before the company can spend a lot of money, it must have available funds – a lot of money is not automatically available. Therefore, companies that consider major capital expenditure plans should plan their financing in advance to ensure that funds are available.
A Key Area for Capital Budgeting in Companies
Tax deductions for interest, excluding dividends and bankruptcy costs, result in a trade-off theory of capital structure. Some debts are desirable because tax credits arise from interest deductions, but the costs of insolvency and financial distress limit the amount that should be used. This is because when the company is highly leveraged, the threat of default risk is enormous. Therefore, the optimal range of debt financing needs to be incorporated into the capital structure policy
This is a very important concept that companies consider in capital budgeting decisions because their capital structure will determine which investment options to pursue. For example, if the company decides to follow the investment advice, the discounted payback period in the later stages of the project is great, although the initial cash outlay is significant. If the company finances heavily through debt, then the risk of the project will be high, because if the short-term future uncertain events, resulting in investment in doubt, may occur default risk. The most recent example of this situation is described below:
The recent crisis in the football industry shows the importance of maintaining tight control over the company's finances. As the industry as a whole became more profitable in the 1990s, many clubs weighed against the theory. In order to incorporate the increased expenditure into the index transfer and wage growth, the club over-borrows to the point where the industry can no longer be sustained. This peaked in May 2002, when the sudden collapse of ITV numbers led to the threat of the bankruptcy of many smaller clubs. This is due to the fact that smaller clubs have bet on the future of their excess funds from ITV Digital. Capital budget decisions are based on short-term gains that allow football clubs to ignore their long-term survival, so in the summer, more than 600 soccer players were laid off to cut costs.
The high-margin semiconductor companies of the mid-1990s, like Samsung, did not turn capital-budgeting policies to higher levels of debt, according to theoretical recommendations. This can be explained by the fact that in the high-tech growth industry, liquid assets are best described as risky and intangible. Therefore, a large amount of borrowing will appear stupid, because in the crisis, the company's current assets will be given no value, resulting in no specific protection against spiral default payments. This seems somewhat pessimistic, given the expectations of expansion and growth during the boom years, but there are many other risk factors that need to be taken into account when making capital budget decisions.
Sales Stability: The Firm's Asset Structure of Stable Sources: When fixed assets are relatively high relative to current assets, they can support higher levels of debt because they can support higher levels of debt.
Due to safety factors.
Operating Levers: The relationship between fixed and variable costs suggests that a high level of operating leverage will result in high levels of fixed costs.
Management Attitudes: Are these attitudes more conservative or aggressive based on the current financial environment and personal style?
Lenders and rating agencies: Corporate credit ratings have an impact on the firm's overall capital structure policy
Top management must understand that information is derived from production capital budgeting decisions and is not limited to financial management. Often within the company, the upper limit of capital budgets set by senior management can cancel any investment project, regardless of their profitability. Therefore, there is a need for a good two-way communication process between senior management and financial management to prevent conflicts from happening.
One way to achieve this is through SWOT analysis. Managers need to understand the company's internal strengths and weaknesses before developing strategies to accomplish the company's goals. This assessment should include the company's financial health, physical capital, human resources, production efficiency and product requirements. External threats and opportunities affecting the ability of the company to achieve its objectives also need to be considered. External threat and opportunity analysis may include assessing the behavior of close competitors or assessing the impact of the business cycle on customer revenue and the resulting demand for the product. SWOT analysis helps companies understand the current constraints imposed by internal and external forces and enables them to take corrective action to better position themselves to achieve their goals.
More information can be used to make informed capital budgeting decisions by properly implementing SWOT analysis. The technology can then be implemented using standard investment assessment techniques such as NPV, discounted payback period, and IRR. The threat of failure is reduced by providing SWOT analysis to help capital budget decisions. However, a review or audit is followed by a final step in reviewing the performance of the investment project after its implementation. Although the expected cash flow is uncertain, the actual value should not be expected to be consistent with the forecast, but the analysis should attempt to find systematic deviations or errors for individuals, departments or departments and try to identify the causes of these errors. Another reason to review project performance is to decide whether to abandon or continue to perform bad projects. Therefore, in order to eliminate bad performance, the risks associated with capital budget decisions must be strictly applied to the audit process to help the decision-making process of future capital budget decisions.