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Approaches to Capital Budgeting

Different Approaches to Capital Budgeting

There are three types of approaches to capital budgeting decisions, depending upon the quality of management These are:

Disaster Approach: In many cases the capital expenditure decisions are taken by capital expenditure management only when a disaster occurs as, for example a plant breakdown. Similarly, when repair or overhaul of plant and machinery is not possible or when it has reached beyond its economic life, capital expenditure (replacement) becomes inevitable. The disaster approach to capital budgeting is, thus, a situation of management by crisis, and a glaring example of bad management.

Passive Approach: Under this approach, the emphasis placed only on current needs. It is a situation of manage as we go, living on day-to-day basis. It is certainly an improvement over the first approach to capital budgeting, but this approach also lacks the wider perspective and long-term realities of changing horizons. In this situation, management is not a plan but an ongoing basis of making current decisions for capital expenditure. Most of the large companies in India will fall under this category.

Dynamic Approach: This is the most modern and effective approach to capital budgeting decisions. In this approach, the emphasis is on long range planning where by symptoms are identified in advance planning. Here, the capital budgeting decisions are based on market research, R and D, and technological changes. In India, there is now a growing awareness in most large companies, especially in the public section, to shift from the Passive to Dynamic approach to capital budgeting, where in the study or scan the changing environments and opportunities of the industry both in India and abroad and plan their capital expenditure decisions accordingly.

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