Textbook Problem

How are project classifications used in the capital budgeting process?

Summary Introduction

To explain: The use of project classification in the process of capital budgeting.

Introduction:

Capital Budgeting:

It refers to the long term investment decisions that has been taken by the top management of a company and that are irreversible in nature. These decisions require investment of large amount of the company’s cash.

Answer to Problem 1Q

The uses of project classification in capital budgeting are,

• To determine the amount of risk factor in the project.
• To estimate the actual time that will be taken by the project.
• To estimate the workload that will be involved in the project.

Explanation of Solution

• Since, the classification of project includes differentiation of two projects on the basis of cost of investment, time involved in the project and the rate of return in the project, it is helpful to estimate the risk factor with every single project in capital budgeting.
• Since, the classification of project is done on the basis of time involved in the project, it is helpful in estimating the actual time that will be taken by each project in capital budgeting.
• Since, the classification of project will involve the amount of work that is to be done in the project, it will be helpful in estimating the workload that will be involved in each project in capital budgeting.

Conclusion

Thus, the project classification in capital budgeting is helpful in determining the risk factor, actual time of the project and the actual workload involved in the project.