A capital budget is a plan for investing in long-term assets such as buildings and machinery
(Wilson, 2016). Various risks are attached to capital budgeting decisions. Management has to
identify, analyze and plan for these risks before making capital budgeting decisions. Different
risks affect different industries or businesses differently so my focus will be on the construction
industry.
One of the most common capital budgeting decisions for a contractor is the purchase of a new
machine. As these machines are very expensive and are meant to be used for a long time detailed
risk analysis is crucial. The most significant risks, in this case, are project-specific risks, currency
risk (international risk), and market risk.
Project risk is an uncertain event or condition that, if it occurs, affects at least one project
objective (Wiley, 2020). Various risks can be grouped into project-specific risks and affect the
outcome of the capital budgeting decision. For a construction project, these risks are unknown
site conditions, natural disasters, weather conditions, and various safety hazards. If these risks
happen they have a major impact on schedules, cost, and performance of the project and
adversely affect the company's profit margin.
The second significant risk is a currency risk which affects capital budgeting decisions. This is
pronounced for companies that operate from a country that has unstable currency like ours.
Currency risk is the possibility of losing money due to unfavorable moves in exchange rates
(Chen, 2021). Our local currency has depreciated by about 24.6% against the dollar since last
year and when contractors want to import new machines the price difference between the time of
budgeting and the actual purchase will be significant. When we add the time value of money into
the equation then the effect will be massive.
The third significant risk is a market risk which is the risk of loss due to the factors that affect an
entire market or asset class. Risks included in market risk include inflation, change in the interest
rate, and change in economic conditions. These risks are hard to predict and can't be diversified
in a normal course of business. In our country, inflation is the most significant market risk and
noticeably affects capital budgeting decisions. Various factors play into this like shortage of
material and political instability however, companies should make proper analysis before making
decisions.
(Wilson, 2016). Various risks are attached to capital budgeting decisions. Management has to
identify, analyze and plan for these risks before making capital budgeting decisions. Different
risks affect different industries or businesses differently so my focus will be on the construction
industry.
One of the most common capital budgeting decisions for a contractor is the purchase of a new
machine. As these machines are very expensive and are meant to be used for a long time detailed
risk analysis is crucial. The most significant risks, in this case, are project-specific risks, currency
risk (international risk), and market risk.
Project risk is an uncertain event or condition that, if it occurs, affects at least one project
objective (Wiley, 2020). Various risks can be grouped into project-specific risks and affect the
outcome of the capital budgeting decision. For a construction project, these risks are unknown
site conditions, natural disasters, weather conditions, and various safety hazards. If these risks
happen they have a major impact on schedules, cost, and performance of the project and
adversely affect the company's profit margin.
The second significant risk is a currency risk which affects capital budgeting decisions. This is
pronounced for companies that operate from a country that has unstable currency like ours.
Currency risk is the possibility of losing money due to unfavorable moves in exchange rates
(Chen, 2021). Our local currency has depreciated by about 24.6% against the dollar since last
year and when contractors want to import new machines the price difference between the time of
budgeting and the actual purchase will be significant. When we add the time value of money into
the equation then the effect will be massive.
The third significant risk is a market risk which is the risk of loss due to the factors that affect an
entire market or asset class. Risks included in market risk include inflation, change in the interest
rate, and change in economic conditions. These risks are hard to predict and can't be diversified
in a normal course of business. In our country, inflation is the most significant market risk and
noticeably affects capital budgeting decisions. Various factors play into this like shortage of
material and political instability however, companies should make proper analysis before making
decisions.
