Chapter 1 Overview 3 
1.1 Capital Investments 3 
1.2 Types Of Capital Investment 3 
1.3 Phases Of Capital Budgeting 4 
1.4 Levels Of Decision Making 6 
1.5 Facets Of Project Analysis 6 
Feasibility Study Schematic Diagram 8 
1.6 Common Weakness In Capital Budgeting 8 

Chapter 2 Strategy & Resource Allocation 10 

2.1 Concept of Strategy 10 
2.2 Grand Strategy 11 
2.3 Portfolio Strategy 12 
BCG Matrix 12 
2.4 Business Level Strategies 12 
2.5 Strategy Planning & Capital Budgeting 12 
Summary 12 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1
 

Chapter 1 Overview 
 

1.1 Capital Investments 

1. Importance 
a. Long term effects 
b. Irreversibility​ - decision once taken for investing into an asset cannot 
be reversed because their can be problems in reselling (the capital 
asset) and scrapping will lead to monetary loss 
c. Substantial outlays -​ in terms of money 
2. Difficulties 
a. Measurement Problems​ - identifying and measuring the costs and 
benefits of a capital expenditure proposal tend to be difficult. Capital 
expenditure have bearing in some other activities of the firm (like 
cutting sales of existing product) or some intangible consequences 
(like improving morale of workers) 
b. Uncertainty ​- involve cost and benefits that extend far into the 
future. Impossible to predict future 
c. Temporal Spread ​- costs and benefits spread over a long period of 
time (10-15 years for industrial and 25-30 years for infrastructure 
projects) 

1.2 Types Of Capital Investment 

 
Can be classified into 
1. PHYSICAL ASSETS​- land, building, etc 
2. MONETARY ASSETS​- bonds, equity etc 
3. INTANGIBLES ASSETS-​ r&d, training, market development etc 
OR 
1. STRATEGIC INVESTMENT - ​ex. Tata motor’s investing in passenger car 
project 
2. TACTICAL INVESTMENT -​ ex. Tata motor replacing current machinery to 
improve productivity 
OR 
1. MANDATORY INVESTMENT ​- require to comply with statutory 
requirements 
2. REPLACEMENT INVESTMENT  
3. EXPANSION INVESTMENT 
4. DIVERSIFICATION INVESTMENT  
5. R&D INVESTMENT  
6. MISCELLANEOUS INVESTMENT ​- interior decoration, recreational facilities 
& landscaping etc. 
2
1.3 Phases Of Capital Budgeting 
 
Capital Budgeting Process  
1. Planning 
2. Analysis 
3. Selection 
4. Financing  
5. Implementation 
6. Review 
 
1. Planning​ - this exercise is meant to assess 
a. Whether the project is prima facie worthwhile to justify a feasibility 
study 
b. What aspects of the project are critical to its viability and hence 
warrant an in depth investigation 
2. Analysis​ - detailed analysis of 
a. Marketing 
b. Technical 
c. Financial 
d. Economic and 
e. Ecological aspects is undertaken. 
 
Based on information from analysis of above, the stream of costs and benefits 
associated with the project can be defined. 
 
3. Selection​ - addresses the question — IS THE PROJECT WORTHWHILE? To 
judge worthwhileness of a project APPRAISAL CRITERIA is divided into two 
broad categories, viz.  
a. non-discounting criteria - Payback Period and Accounting Rate of 
Return 
b. Discounting criteria - Net Present Value, Internal Rate of Return and 
the Benefit Cost Ratio 
 
Criterion   Accept  Reject 

Payback Period (PBP)  PBP < target period  PBP > target period 

Accounting Rate of  ARR > target rate  ARR < target rate 
Return (ARR) 

Net Present Value (NPV)  NPV > 0  NPV < 0 

Internal Rate of Return  IRR > cost of capital  IRR < cost of capital 
(IRR) 

Benefit Cost Ratio (BCR)  BCR > 1  BCR < 1 

 
To apply the various appraisal criteria, suitable cut-off values (hurdle rate, target 
rate, and cost of capital) have to be specified.  
3
ARR = A
​ verage Annual profit 
Initial Investment 
 
BCR = Discounted value of incremental benefits ÷ Discounted value of 
incremental costs 
 
4. Financing​ - Two broad sources of finance: 
a. Equity 
b. Debt [Flexibility, Risk, Income, Control and Taxes (FRICT) are the key 
business considerations that indulgence the capital structure 
(debt-equity ratio) decision.] 
 
5. Implementation -​ for expeditious implementation at a reasonable cost, the 
following are helpful: 
a. Adequate Formulation of Projects ​- preliminary studies and 
comprehensive and detailed formulation of the project is necessary 
to minimise risk 
b. Use of the Principle of Responsibility Accounting​ - Assigning specific 
responsibilities to project managers for completing the project 
within the defined time-frame and cost limits is helpful in 
expeditious execution and cost control 
c. Use of Network Techniques​ - For project planning and control two 
basic techniques are available 
■ PERT (Programme Evaluation Review Technique) 
■ CPM (Critical Path Method) 
 
6. Review -​ this is a periodical feedback device to compare actual 
performance with projected performance, which is useful in several ways, 
viz 
a. Throws light on how realistic our assumptions were 
b. It provides us with database of experience which can be used for 
future decision making 
c. It suggests corrective action to be taken in light of actual 
performance 
d. It helps uncovering judgmental biases 
e. It induces a desired caution among project sponsors 
 
 
 
 
 

4
1.4​ L
​ evels Of Decision Making 

 
 
  Operating  Administrative  Strategic 
Decisions  decisions  decisions 

Where the  Lower level  Middle-level  Top- level 

decision is taken  management  management   Management 

How structured is  routine  Semi-structured  Unstructured  

the decision 

What is the level  Minor Resource  Moderate  Major Resource 

of resource  commitment  resource  commitment  
commitment   commitment  

What is the time  Short-term  Medium Term  Long term 

horizon  
 
Eg.: 
Operating capital budgeting decision - Minor Office Equipment 
Administrative capital budgeting decision - Balancing Equipment 
Strategic Capital Budgeting Decision - Diversification Project 

1.5 Facets Of Project Analysis 

 
Important facets of project analysis are: 
 
❏ Market Analysis 
❏ Technical Analysis 
❏ Financial Analysis 
❏ Economic Analysis 
❏ Ecological Analysis 
 
Market Analysis M ​ arket analysis is concerned primarily with two questions: 
 
● What would be the a ​ ggregate demand​ of the product/ services? 
● What would be the m ​ arket share​ of the project? 
 
To answer the above questions these are the information required: 
 
● Consumption​ trend in the past and the present consumption level 
● Past and present S ​ UPPLY​ position 
● Production ​possibilities and constraints 
● Imports and exports 
● Structure of c ​ ompetition 

5
 ● Cost s​ tructure 
● Elasticity of demand 
● Consumer behaviour, i​ ntentions, motivations, attitudes, preferences and 
requirements 
● Distribution channels a​ nd ​marketing policies 
● Administrative, technical and legal constraints 
 
Technical Analysis 
 
Financial Analysis  
● Investment outlay & cost of project 
● Means of financing 
● Cost of capital 
● Projected profitability  
● Break even point 
● Cash flows of the project 
● Investment worthwhileness (various criteria of merit) 
● Projected financial position 
● Level of risk 
 
Economic Analysis  
 
Ecological Analysis  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

6
 

Feasibility Study Schematic Diagram 

 

 
 

1.6 Common Weakness In Capital Budgeting 

 
■ Poor Alignment between Strategy & Capital Budgeting 
■ Deficiencies in Analytical Techniques 
➢ The base case is poorly identified -​ “what happens to the firm 
without the project” has to be specified. The worse the base case, 
the more attractive the project will be 
➢ Risk is Treated Inadequately 
➢ Options are not Properly Evaluated  
➢ Lack of Uniformity in Assumptions​ - varying assumptions about 
economy growth rate, inflation rate, residual value, capital cost, etc 
➢ Side Effects are Ignored 
■ No Linkage between Compensation & Financial Measures 

7
 ■ Reverse Financial Engineering - quality of information used in capital 
budgeting is compromised 
■ Weak in Integration between Capital & Expense Budgeting 
■ Inadequate Post-Audits 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

8
 Strategy & Resource 
Chapter 2 ​

Allocation 
2.1 Concept of Strategy 
 
Formulation of Strategies 
 

9
2.2 Grand Strategy 
Thrust of Grand Strategy 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10
Exhibit S
​ trategies, Principal Motivations, & Likely Outcomes 
 
 
    Likely Outcomes 
Strategy  Principal Motivation 
Profitability  Growth  Risk 

Concentration  -​Ability to serve a  High  Moderate  Moderate 

growing market 
-​Familiarity with 
growing market 
-​Cost Leadership 

Vertical  -​Greater stability for  High  Moderate  Moderate 

Integration  existing & proposed 
operations 
-​Greater Market 
Power 

Concentric  -​Improve utilisation of  High  Moderate  Moderate 

Diversification  resources 

Conglomerate  -​Limited scope in the  Moderate  High  Low 

Diversification  present business 

Stability   -​Satisfaction with  High  Low  Low 

status quo 

Divestment  -​Inadequate profit  High  Low  Low 

-​Poor strategy 
 

2.3 Portfolio Strategy 

BCG Matrix 

    Market Share 

    High  Low 

High  Stars  Question Marks 

Market Growth Rate 
Low  Cash Cows  Dogs 

11
2.4 Business Level Strategies 

2.5 Strategy Planning & Capital Budgeting 

Summary 

12