Methods of capital budgeting- 1. ARR method 2. Payback method and example

1. BY ASIMANANDA MAHATO
Methods OF Capital
Budgeting

2. Capital Budgeting
 Capital budgeting is the planning process used
to determine a firms long term investments .
Such as new machinery , replacement
machinery, new products etc.
 The term capital budgeting is otherwise called
as investment appraisal .

3. Capital Budgeting Process
1) Planning
2) Analysis : a. Market analysis
b. Technical analysis
c. Financial analysis
d. Economic analysis
1) Selection
2) Implementation
3) Review

4. Objectives Of Capital Budgeting
 To find out the profitable capital
expenditure.
 To decide whether a specified
project is to be selected or not.
 To evaluate the merits of each
proposal to decide which project is
best.
 To assess the various sources of
finance for capital expenditure.

5. Methods Of Capital Budgeting
 Net present value
 Internal rate of return
 Accounting rate of return
 Payback period
 Profitability index

6. Accounting Rate of Return
 Average rate of return also known as accounting rate of
return is defined as average cash inflows (Benefits)
against unit investment
ARR on Average investment = Average Profit After Tax * 100
Average investment
ARR on Initial investment = Average Profit After Tax *100
Initial investment

7. Pay Back Period
 In discounted pay- back period method, the cash inflows are
discounted by applying the present value factors for different
time periods. For this, discounted cash inflows are calculated
by multiplying the P.V. factors into cash inflows.
Dis. PBP = Completed years + Required inflow *12
In flow of next year

8. Example
The cost of plant is Rs.500000.It has been
estimated life of 5 years after which it would
be deposited off(scrap value nil).Profit
before depreciation, interest & taxes(PBIT) is
estimated to be Rs. 175000 p.a. Find out the
yearly cash flow from the plant. Tax rate
30%.