Financial Management & Cost Accounting

Lesson 24. INTRODUCTION, NATURE OF INVESTMENT DECISIONS, TYPE OF CAPITAL BUDGETING DECISIONS

Module 5. Investment decision

Lesson 24

INTRODUCTION, NATURE OF INVESTMENT DECISIONS, TYPE OF CAPITAL BUDGETING DECISIONS

24.1 Introduction

It is a general practice that the benefit-cost analysis of the projects is worked out considering the market prices at the time the project is proposed to be taken up. But, such procedure will not be sufficient for economic analysis of agricultural projects, because the project is not going to be operated in perfect marketing situations, wherein, prices reflect the relative scarcity value of various goods and services. But, in developing countries a market is protected through various Governmental measures and there will be scarcity of foreign exchange and hence, market price of goods and services often do not provide a reliable guide to the costs and returns of the projects. So, it is appropriate to consider the costs and values of the inputs and outputs of the projects at the international exchange rates, i.e., border rates excluding the effects of domestic tariff, subsidies, excise and other taxes in the economic analysis of the projects.

24.1.1 Cost aspects

Annual capital costs of the project at current prices must be ascertained and then they should be weighted by the price index in order to get the cost at constant prices. Afterwards the same is multiplied by the Construction Conversion Factor (CCF) to get the economic costs of the project.

The CCF also plays a crucial role in giving weightage to the different commodities and inputs of the projects, such as traded commodities, non-traded commodities and services and unskilled labourers. The traded commodities include capital-intensive works which require imported machinery and material. In this case the Construction Conversion Factor (CCF) is taken as one. The non-traded commodities (goods) and services include works, which require skilled labourers and locally manufactured material. In this case, a conversion factor of 0.8 is used to get the economic value of these goods and services. The conversion factor of unskilled labourer employed in the project work is around 0.75. This is based on the rationale of considering the extent of employment and unemployment and migration of labourers from agriculture to other sectors.

Investment in agriculture is of two types. The first type involves operating investment such as seed, feed, fertilizers, etc., and the second one is concerned with capital assets such as land, machines, projects, etc.

Analysis of investment is different for these categories of investment, owing to differences in timing of expenses and their associated returns. Investment on operating inputs occurs within one production cycle of a year or sometimes less, but investment on capital assets entails a longer time period.

In the profit maximization principle, time is not brought into consideration because both expenses and returns are assumed to fall in the same production cycle. But, capital investments made in agricultural projects are made in different time periods and the returns are also spread over time. In order to assess the returns from investments, available alternatives must be weighted for different lengths of time in respect of costs and returns i.e., recognition of time value of money, profitability and economic viability of capital investment.