Categories of Capital Budgeting Projects
Categories of capital budgeting projects may be divided in the following categories:
- Replacement projects to maintain the business
- Replacement projects for cost reduction
- Expansion projects
- New product or market development
- Mandatory projects
- Other projects
On this page, we discuss each of these categories of capital budgeting projects in more detail. This classification can be used by financial analysts to judge capital budget decisions. To aid the capital budgeting process, we can rely on the principles of capital budgeting.
Replacement projects to maintain the business
The first category is replacement projects to maintain the business. These are normally made without detailed analysis. The only issues are whether the existing operations should continue and, if so, whether existing procedures or processes should be maintained.
Replacement projects for cost reduction
The second category is replacement projects for cost reduction. These projects determine whether equipment that is obsolete, but still usable, should be replaced. A fairly detailed analysis is necessary in this case.
Expansion projects are taken on to expand the business and involve a complex decision-making process since they require an explicit forecast of future demand. A very detailed analysis is required.
Mandatory projects may be required by a governmental agency or insurance company and typically involve safety-related or environmental concerns. These projects typically generate little to no revenue, but they accompany new revenue-producing projects undertaken by the company.
Other projects are not easily analyzed through the capital budgeting process. Such projects may include a pet project of senior management (e.g. corporate perks), or a high-risk endeavor that is difficult to analyze with typical capital budgeting assessment methods (e.g. research and development projects).
We discussed different categories of capital budgeting projects. When evaluating these kinds of projects, we can rely on 5 principles of capital budgeting.