Capital budgeting

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finance presentation on capital budgeting

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Capital budgeting

  1. 1. By:Suvash Timalsina (142)
  2. 2.  The process of decision making with respect to investments in fixed assets—that is, should a proposed project be accepted or rejected
  3. 3.    Determine whether a new project should be accepted or rejected using the payback period, net present value, the profitability index, and the internal rate of return Discuss the trends in the use of different capitalbudgeting criteria Cash flow assesment
  4. 4.     The Payback Period Net Present Value Profitability Index Internal Rate of Return
  5. 5. Example: Project with an initial cash outlay of Rs20,000 with following free cash flows for 5 years. YEAR CASH FLOW BALANCE 1 Rs 8,000 (Rs 12,000) 2 4,000 ( 8,000) 3 3,000 ( 5,000) 4 5,000 0 5 10,000 12,000 PBP= min. yr+ amt. to be recovered/ nxt yr cash flow Payback is 4 years.
  6. 6. With undiscounted free cash flows, the payback period is only 2 years while with discounted free cash flows (at 17%), the discounted payback period is 3.07 years
  7. 7.  Meaning: NPV is equal to the present value of all future free cash flows less the investment’s initial outlay. It measures the net value of a project in today’s dollars.
  8. 8.  Example: Project with an initial cash outlay of $60,000 with following free cash flows for 5 years. Year Initial outlay 1 2  FCF –60,000 –25,000 –24,000 Year 3 4 5 FCF 13,000 12,000 11,000 The firm has a 15% required rate of return.
  9. 9.     PV of FCF = $60,764 Subtracting the initial cash outlay of $60,000 leaves an NPV of $764. Since NPV > 0, project is feasible.
  10. 10.  Meaning: PI is the ratio of the present value of the future free cash flows (FCF) to the initial outlay. It yields the same accept/reject decision as NPV. PI = PV of FCF/Initial outlay
  11. 11. FCF PVF @ 10% PV –$50,000 1.000 –$50,000 Year 1 15,000 0.909 13,636 Year 2 8,000 0.826 6,612 Year 3 10,000 0.751 7,513 Year 4 12,000 0.683 8,196 Year 5 14,000 0.621 8,693 Year 6 16,000 0.564 9,032 Initial Outlay
  12. 12. PI = ($13,636 + $6,612+$7,513 + $8,196 + $8,693+ $9,032) / $50,000 = $53,682/$50,000 = 1.0736 Project’s PI is greater than 1. Therefore, accept.
  13. 13.   Meaning: IRR is the discount rate that equates the present value of a project’s future net cash flows with the project’s initial cash outlay Decision Rule: ◦ If IRR Required Rate of Return, accept ◦ If IRR < Required Rate of Return, reject

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