This is an PPT on Capital Budgeting by various group of students.

1. PRESENTED BY :- CLASS :- MCA ii
MEGHAJ MALLICK (MCA/25017/18) SUBMITTED TO:
AKASH KUMAR CHAUBEY (MCA/25014/18) PRIYANSHU SIR SHRADDHA MALVIYA
(MCA/25018/18)
DIVYANSH PARMARTHI (MCA/25016/18)
SAJAN SINGH (MCA/25019/18)

2. Definition of Budget
 Budgeting is a management tool for planning
and controlling future activity.
 The plan for saving ,borrowing and spending.
 Budget is a financial plan and a list of all
planned expenses and revenue

3. Budget Sector Budget Types
4
Basis of Flexibility:Fixedand VariableBudget
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.
Buisness
start-up
budget
Corporate/
Buisness
budget
Government
budget
Event
management
budget
Personal/
Familybudget

4. 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.

5. Importance of Capital Budgeting
Growth
Large Amount
Irreversibility
Complexity
Risk
Long term implications
Benefits of Capital Budgeting Decision:
Capital Budgeting decisions evaluate a proposed project to forecast
return from the project and determine whether return from the Project is
adequate.
Capital Budgeting decisions evaluate expenditure decisions which
involve current outflow of funds but are likely to produce benefits over a
period of time more than one year.

6. Capital Budgeting: Project
Categorization
• Establishment of New Products & Services
• Replacement Projects: Maintenance or Cost
Reduction
• Expansion of Existing Projects
• Research and Development Projects
• Long Term Cotracts
• Safety and/or Environmental Projects

7. 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 andresearch & developmentprojects.

8. PAYBACKMETHOD
Pay back method, also known as pay-out /or pay-
off period method, is a simple
technique for taking capital budgeting decision.
Under this method the investment
decision is based on pay-back period.The payback
period is the period within which
the investment in capital asset will be recovered
out of annual savings arising out of
investment decision.

9. For example :if a machine is acquired for Rs.1,50,000 and it
fetches Rs.30,000 as income in the first year, Rs.60,000 in
the second year and
Rs.60,000 in the third year.The total cost of machine will
be recovered fully within 3
years hence the pay back period is 3 years, since pay back
period is calculated by
following formula
Pay-back period =
Net Investment / Net Cash Inflow Per Annum

10. ( Note:
Net Cash Inflow refers to earning from
investment before charging interest
and depreciation but after charging
taxes)
 All alternative investment proposals
are ranked according to the payback
period and
only that alternative is approved which
has relatively lesser payback period.

11. POST PAY BACK METHOD
 Aspointedoutearlier,underpaybackmethodtheprofitability(iecash
inflows)afterpaybackperiodisignored.thepostpaybackmethod has
beenevolvedtoovercomethislimitation.
underpostpaybackmethodtheentirecashinflowsgeneratedfroma
projectduringitsworkinglifearetakenintoaccount.Thepostpay
backprofitabilitycalculatedas under
paybackprofitability= totalcashinflowsinlife- initial
cost.

12. For example:- Ifthecostofprojectis Rs.100000andthecashInflow
are;
1styear Rs10000andyearRs.15000,
3rrdyear Rs.2,5000
4thyear Rs.30,000and
5Thyear Rs30,000.
Postpaybackprofitability=
totalcashinflowsinlife – initialcost.
1,10,000-100000= 10000
postpaybackprofitability= 10000

13. Advantages :-
1. It is easy to understand and simple to operate.
2. It is suitable if the firm facing shortage of funds because it gives
importance to investments which do speedy recovery of funds.
3. It is suitable if there is a fear of project being obsolete in short
period of time.
4. It is suitable for industries where rapid technological changes
take place.
5. It is suitable for evaluating the projects where the returns (or
savings) beyond
three or four years are uncertain hence cannot be considered in
making decision.

14. 1. This method gives undue emphasis on fast recovery of
invested fund ignoring the profitability of investments. It ignores
the income from investment beyond payback
period hence it may lead to wrong decisions.
2. It ignores the 'interest factor' which is very important factor in
making investment decisions.
3. It causes management to overlook many profitable investment
opportunities because they are slow starters and only gather
momentum after few years of
operation.
Disadvantages

15. 4. It gives importance to return of cash rather than
return of profits on investment.
5. It does not make correct appraisal of investments
because it does not consider the
full economic life of the project but only its early years.
Inspite of all these limitations, this method is popularly
used in industries where
technological changes are frequent, future is uncertain
and risk of obsolescence is
more, necessitating the prompt pay back of investment
in projects.

16. BRIEFTOTHECASE
• In this case Mr. Gupta who owns a Brick making company
called Gupta Bricks based in MP.
• The Business is operating under full capacity
• Capacity of Brick production is limited by Bull trench
kiln (BTK) the most commonly used technology for
firing the bricks.
• Mr. Gupta owns 2 BTKs- average capacity of 30,000
bricks per day.
• Annual production of about 75 lac bricks per BTK when
operating for 250 days.

17. • Construction industry is passing through a boom
where real estate prices were rising, tremendous
demand was there due to new construction
and rebuilding and the prices were increasing
from last 2 years.
• A new technology -VSBK ( Vertical shift brick
kiln) has come into the market recently and
promises to expedite the process and increase
production by about 10-15%.

18. • VSBK technology is environment friendly.
• It is better for the health and safety of the brick
kiln workers.
• This technology was tried and tested successfully
by several organizations.
• Expected to reduce fuel costs by about 20%.
• It gives flexibility of operation, good product
quality and substantial saving in energy costs.
• Products are superior to those produced by
BTKs and could fetch about 3% higher prices.
VSBK-Vertical Shift Brick Kiln

19. Advantage of using VSBK
technology :
• Saved fuel cost.
• Bricks remain inside the kiln for 24-30 hours as
compared to 20-30 days in the BTK technology
• Thus, Working capital reduced substantially.

20. Whether or not Mr. Gupta should replace one
of his BTKs with three 2 –shafts
VSBKs?
QUESTION TOBE
ANSWERED

21. Production 15000000 Per ‘000
Raw material 5100000 0.34
Labor 3300000 0.22
Fuel 3300000 0.22
Overheads 1050000 0.07
Revenue 16500000 1.10
Cash profit (Revenue –
all expenses)
3750000 0.25
Depreciation 100000 0.01
Existing situation

22. Production 16500000 Per ‘000
Raw material 5610000 0.34
Labor 3960000 0.24
Fuel 1155000 0.176
Overheads 2904000 0.07
Depreciation 350000
Depreciation = (100000*3)= 300000
=300000+50000 (50000 being
depreciation of 1 BTK)
= Rs. 350000
Proposed investment

23. 3VSBK 1 BTK
Production /annum 9000000 7500000
Production/day 30000 30000
Revenue 10197000 8250000
Cash outflow 3000000 -

24. Rs. (p.a.) Per unit
Maintenance cost 60,000
Raw material 5,10,000 0.34
Wages 3,60,000 0.24
Overheads 1,05,000 0.07
Fuel (2,64,000) 0.176
Depreciation 2,50,000
Total expenses 10,21,000
Revenue 1699500
Profit 678500
Tax 61065 0.09
Profit after tax 617435
Net cash flow (PAT +
Dep.)
867435
PVCI (Net cash flow
*5.216)
4524540
Incremental cash flows

25. • Pay back period = Initial Investment /
CashInflow per Period
= 30,00,000/ 867,435
= 3.458 years
• NPV = Total PV - Initial Outlay
= 45,24,540-30,00,000
= Rs. 15,24,540.

26. As payback period is less than 5 years i.e.
3.458 as expected by Mr. Gupta and NPV , at
cost of capital 14% , is coming out to be
positive i.e. Rs. 15,24,540 , so it is advised
that Mr. Gupta should replace one of its BTK
with two shafts VSBK.
CONCLUSION

27. Net present Value(NPV)
Net present value (NPV) is the difference
between the present value of cash inflows and
the present value of cash outflows over a
period of time. NPV is used in capital
budgeting and investment planning to analyze
the profitability of a projected investment or
project.

28. Advantage of net present
value
 NPV gives important to the time value of
money.
 In the calculation of NPV , both after cash flow
and before cash flow over the span of the
project are considered.
 NPV helps in maximizing the firm’s value.

29. Internal Rate of Return
(IRR)
The internal rate of return is a discount
rate that makes the net present
value(NPV) of all cash flows from a
particular project equal to zero. IRR
calculation rely on the same formula as
NPV does.

30. Advantage of IRR
 IRR is indicating a rate of return of a project.
 IRR method shows the return on the original
money invested.
 No need to calculate the cost of capital.

31. NPV OVER IRR
 NPV calculated in terms of currency while
IRR is expressed in terms of the percentage.
 The IRR method cannot be used to evaluate
projects where there are changing in cash
flows.
 NPV calculate additional wealth.

32. • Accounting rate of return is the ratio of estimated
accounting profit of a project to the average
investment made in the project.
• The accounting rate of return is a capital
budgeting metric useful for a quick calculation of
an investment's profitability.

33. Accounting Rate of Return is calculated using
the following formula:
Accounting rate of return = Average Accounting
Profit
Average Investment

34. An initial investment of 130,000 Rs. is expected
to generate annual cash inflow of 32,000 Rs.
for 6 years. Depreciation is allowed on the
straight line basis. It is estimated that the
project will generate scrap value of 10,500 Rs.
at end of the 6th year. Calculate its accounting
rate of return assuming that there are no other
expenses on the project.
Solution -
Example:

35. Annual Depreciation =
(Initial Investment − Scrap Value) ÷Years
Annual Depreciation = (130,000 − 10,500) ÷ 6 = 19,917
Average Accounting Income = 32,000 − 19,917 =12,083
Accounting Rate of Return = 12,083 ÷ 130,000=9.3%

36.  ARR is helpful in determining the annual
percentage rate of return of a project.
 ARR is based on accounting information,
therefore, other special reports are not
required for determining ARR.
 ARR method is easy to calculate and simple
to understand.

37.  ARR method is based on accounting profit
hence measures the profitability of
investment.

38.  ARR ignores the time value of money.
 ARR method ignores the cash flow from
investment.
 ARR method does not consider terminal value of
the project.
 This technique is based on profits rather
than cash flow.

39. Benefit-Cost Ratio :-

40. Profitability Index (PI) or Benefit-Cost
Ratio :-
□ Profitability Index (PI) is a capital
budgeting technique to evaluate the investment
projects for their viability or profitability.
Discounted cash flow technique is used in arriving
at the profitability index. It is also known as a
benefit-cost ratio. Calculation of profitability index
is possible with a simple formula with inputs as –
discount rate, cash inflows, and outflows. PI greater
than or equal to 1 is interpreted as a good and
acceptable criterion.

41. PROFITABILITY INDEX
DEFINITION
❑ Profitability Index is a ratio of discounted cash
inflow to the discounted cash outflow. Discounted
cash inflow is our benefit in the project and the
initial investment is our cost, which is why we also
call it benefit to cost ratio.

42. PROFITABILITY INDEX METHOD:-
□ The method used for arriving at profitability index of a
proposed project is explained stepwise below :-
▣ a)Find the expected cash inflows of the project
▣ b) Find the cash outflows of the project (Initial Investment +
any other cash outflow)
▣ c) Decide an appropriate discount rate
▣ d) Discount the expected cash inflows using the discount rate
▣ e) Discount the future cash outflows and add to initial
investment
▣ f) Divide step (d) by step (e)

43. HOW TO CALCULATE THE
PROFITABILITY INDEX
▣ The calculation of PI is easily possible once we
have the cash inflows and outflows with appropriate
discount rate are in place.
▣ PROFITABILITY INDEX FORMULA :-
▣ The formula indicates the benefits in the numerator
and costs in the denominator. The formula for
calculating Profitability Index is as follows □
present value of cash inflow / present value of cash
outflow.

44. PROFITABILITY INDEX (PI) AND
NET PRESENT VALUE (NPV)
▣ Profitability Index is closely linked with net present
value. Both will present same results as far as
acceptance and rejection are concerned. It is because
the almost same calculation is followed in both. In
PI, we divide our benefits by our costs whereas, in
NPV, we deduct our costs from the benefits. PI will
give a relative value and contrarily.

45. EXAMPLE OF PROFITABILITY
INDEX(PI):-
Given as NPV 10 % DISCOUNT
Year 0 1
5
2 3 4
CF (50,000) 10,000
19,750
10,650 12,600 13,250
PVF(10%) 1 0.909
0.621
0.826 0.751 0.683
PV (50,000) 9090 8797 9463 9050
12265 = NPV -> (- 1335)

46. • Firstly Find Present Value Factor (PVF) at 10% using
PVF formula-> CF *1/(1+r)^t
Where CF is Cash Inflows, r is Discounted Rate and t is
time (Year of project Life).
Applying Profitability Index (PI) Formula -: Present
value of cash inflow / present value of cash outflow.
Present value of cash inflows □ 9090 + 8797 + 9463 +
9050 + 12265 = 48665
Present value of cash outflow □ 50,000 (Project Cost or
Initial Investment)
Find PI = 48665 / 50,000 □ 0.9733 times.

47. PROFITABILITY INDEX –
ADVANTAGES AND
DISADVANTAGES:-
✔ The advantage of profitability method is that it considers the time value of
money(TVM or Minimum Desire Return or Opportunity cost of capital or
Discounted Rate) and presents a relative profitability of the project.
Relative profitability allows comparison of two investments irrespective of
their amount of investment. A higher PI would indicate a better IRR
(Internal Rate of Return) and a lower PI would have lower IRR.
✔ It is difficult to understand interest rate or discount rate.
It is difficult to calculate profitability index if two projects having different
useful life.

48. REFERENCE
1. WWW.WIKIPEDIA.ORG
2. FINANCIALMANAGEMENT
AUTHOR:VINOD(BBACALICUT UTY)