Page 2 - Lesson Note 5

Fixed Assets should never be financed through short-term sources.

Investment in these assets would also include expenditure on

acquisition, expansion, modernization and their replacement. These

decisions include purchase of land, building, plant and machinery,

launching a new product line or investing in advanced techniques of

production.

Major expenditures such as those on advertising campaign or research
and development programme having long term implications for the

firm are also examples of capital budgeting decisions.

The management of fixed capital or investment or capital budgeting

decisions is important for the following reasons:

(i) Long-term growth: These decisions have bearing on the long-

term growth. The funds invested in long term assets are likely

to yield returns in the future. These will affect the future
prospects of the business.

(ii) Large amount of funds involved: These decisions result in a

substantial portion of capital funds being blocked in long-term

projects. Therefore, these investments are planned after a

detailed analysis is undertaken. This may involve decisions like
where to procure funds from and at what rate of interest.

(iii) Risk involved: Fixed capital involves investment of huge

amounts. It affects the returns of the firm as a whole in the

long term. Therefore, investment decisions involving fixed

capital influence the overall business risk complexion of the
firm.

(iv) Irreversible decisions: These decisions once taken are not

reversible without incurring heavy losses. Abandoning a project