It's about the financial Accounting and the topic is "Capital Budgeting". where you will get to know about the meaning of Capital budgeting its importance in finance and also its futher categories and its merits and demerits. conclusion is given in end.

1. START WITH THE NAME OF ALLAH
WHO IS MOST MERCIFUL AND
BENEFITIAL
Kainat Aslam

2. Capital
budgeting
Presentation Topics
Kainat Aslam

3. Kainat Aslam

4. • Capital Budgeting
• Meaning of Capital Budgeting
• Budget sector and types of budget
• Importance of Capital Budgeting
• Eight steps of Capital Budgeting
• Factors of Capital Budgeting
• Evaluation Criteria : Capital investment proposal
• Merits and demerits of Capital Budgeting
• conclusion
Capital Budgeting
Kainat Aslam

5. Capital budgeting:
 Capital: Operating
assets used for
production.
 Budget: A plan that
details projected cash
flows during some
period.
 Capital Budgeting:
Process of analyzing
projects and deciding
which ones to include
in capital budget.Kainat Aslam

6. Meaning:
 The process through which different projects are
evaluated is known as capital budgeting “Capital
budgeting is long term planning for making and
financing proposed capital outlays”- Charles T
Horngreen.
Kainat Aslam

7. Budget Sector
Budget Type
Business start-up budget
Corporate/ Buisness budget
Government budget
Basis of Flexibility : Fixed and
variable budget
Basis of time period: Short-term and
long-term budget
Basis of Functionality: sales budget,
Production budget , Marketing
budget, Project
budget, Revenue budget, Cash
flow/cash
budget etc.
Event Management
budget
Personal / Family budget
Kainat Aslam

8. Importance of Capital Budgeting:
 Growth
 žLarge Amount
 žIrreversibility
 žComplexity
 žRisk
 žLong term implications
Kainat Aslam

9. Capital Budgeting is the planning process used to determine a firm’s
long term investments such as new machinery, replacement machinery,
new plants, new products and research & development projects.
Kainat Aslam

10. Kainat Aslam

11. Capital budgeting:
 Availability of funds
 Structure of capital
 Taxation policy
 Government policy
 Lending policies of financial institutions
 Immediate need of the project
 Earnings
 Capital return
 Economical value of the project
 Working capital
 Accounting practice
 Trend of earnings
Kainat Aslam

12. Evaluation Criteria: Capital Investment
Proposal
Evaluation Criteria
Non-discounting Criteria Discounting criteria
Pay-Back
Period
ARR
Discount
ed
PBP
NPV
Profitability
Index IRR
Kainat Aslam

13. Non discounting: Pay-Back Period:
 1. Pay-Back Period Method- It is defined as the
number of years required to recover original cost
invested in a project. It has two conditions
 When cash inflow is constant every year
 PBP= Cash outflow/cash inflow (p.a.)
 Ø When cash inflow are not constant every
year
 PBP = Completed years +
Required cashflow
inflow of next year
* 12
Kainat Aslam

14. Merits Demerits
 1. It is a ready method,
both in concept and
application. It does not
use involved concepts
and tedious calculations
and has few hidden
assumptions.
 2. Since it emphasizes
earlier cash inflows, it
may be sensible
criterion when the firm
is facing the problem of
liquidity.
 1. A company can have more
favorable short-run effects
on earning per share by
setting up a shorter payback
period. It should, however,
be remembered that this
may not be a wise long term
policy as the company may
have to sacrifice its future
growth for current earnings.
 2. The emphasis in pay back
is on the early recovery of
the investment. Thus, it
gives an insight to the
liquidity of the project. The
funds so released can be put
to other uses.Kainat Aslam

15. Non discounting Criteria: Annual
Rate of Return:
 2.Average Rate of Return Method - ARR means
the average annual earning on the project. Under
this method, profit after tax and depreciation is
considered. The average rate of return can be
calculated in the following two ways.
 ARR on Average investment =
Average profit after Tax
Average Investment
* 100

 ARR on Initial investment =
Average profit after Tax
Initial Investment
*Kainat Aslam

16. Merits Demerits
 1. Net earnings after
depreciation are
considered under this
method and this is of
vital importance in the
appraisal of
investment proposals.
 2. It is an easy
method to adopt and
simple to understand.
 1. This method, like the
pay back method, does
not consider the time
value of money.
 2.ARR uses accounting
approach in place of cash
flow approach. For this
reason, it does not truly
reflect the proper timing of
the benefits. Thus, it
ignores the reinvestment
potential of a project.
Kainat Aslam

17. Discounting Criteria: Pay-Back
Period:
 3. Discounted Pay-Back Period Method - 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
inflow of next year
*
12
Kainat Aslam

18. Discounting Criteria: Net Present
Value:
 4. Net Present Value Method:- It is the best method
for
 evaluation of investment proposal. This method takes
into
 account time value of money.
 NPV= PV of inflows- PV of outflows
 Evaluation of Net Present Value Method:- Project
 with the higher NPV should be selected.
 Accept if NPV>0
 Reject NPV<0
 May or may not accept NPV=0Kainat Aslam

19. Merits Demerits
 1. It considers the cash
flow streams in its entirety.
 2. The net present value
of various projects
measured as they are in
today’s money value can
be added. For example,
the net present value of a
package consisting of two
projects, A and B will
simply be the sum of the
net present value.
 1. The major limitation of
this method is that it
requires detailed long
term forecasts (estimates)
of the incremental
benefits and costs. There
may also arise difficulty in
deciding the appropriate
rate of discount for finding
the values of the cash
flows coming in over the
project’s life. The relative
desirability of an
investment proposal may
change with a change in
the discount rate.Kainat Aslam

20. Discounting Criteria: Profitability
Index:
 5. Profitability Index Method - As the NPV
method it is also shows that project is accepted or
not. If Profitability index is higher than 1, the
proposal can be accepted.
 Accepted PI>1
 Rejected PI<1
 Profitability index =
total cash inflow
Total cash outflow
Kainat Aslam

21. Merits:
 1. It is consistent with the goal of maximizing the
shareholders wealth.
 2. It uses cash flows.
 3. It recognizes the time value of money. Demerit:
 The main demerit of this method is that it requires
detailed long term forecasts of the incremental
benefits and costs. It also poses difficulty in
determining appropriate discount rate.
Kainat Aslam

22. Discounting Criteria: Internal Rate
of Return:
 6. Internal Rate of Return Method:- IRR is the rate
of return that a project earns. The rate of discount
calculated by trial and error , where the present value
of future cash flows is equal to the present value of
outflows, is known as the Internal Rate of Return.
 IRR = Higher Rate -
NPV of Higher Rate
Difference in cash flows
* difference in
rate
 IRR = Lower Rate +
NPV of lower Rate
Difference in cash flows
* difference in
rateKainat Aslam

23. Merits Demerits
 1. It recognizes the time
value of money.
 2. It is consistent with the
objective of maximizing
shareholders’ wealth.
 3. It does not use the
concept of the cost of
capital but itself provides
a rate of return which is
indicative of the
profitability of the
investment proposal.
 4. It takes into account the
total cash inflows and
outflows.
 1. Possibility of
multiple IRRs remains
in same situation
which reduces the
utility of this method.
 2. It requires detailed
long term forecasts of
incremental benefits
and costs.
 3. It involves tedious
calculations.
Kainat Aslam

24. Kainat Aslam

25. Conclusions:
 We have Studied various evaluation criteria for
Capital Budgeting.
 Generally an impression created that the firm
should use NPV method for decision making.
 Most of the large companies consider all the
measures because each one provides somewhat
different piece of relevant information to the
decision maker
Kainat Aslam

26. THANK YOU
Kainat Aslam