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1. CAPEX

2. Financial decisions taken by a firm
Investment decisions
•Long term investment decisions
•Short term investment decisions
Financing decisions
Profit allocation decisions

3. CAPEX decision
 CAPEX relates to selection of an asset or investment
proposal or course of action whose benefits are
likely to be available in future over the lifetime of the
project.
 Capital Budgeting is the Total process of generating,
evaluating, selecting and following up on capital
expenditures.

4. Why CAPEX decisions?
 Expansion
 Diversification
 Replacement
 Modernization

5. Significance of CAPEX decisions
 Huge Expenditure
 Long term decision and consequence
 Irreversible
 Very risky
 Strategic

6. BASIC STEPS OF CAPITAL BUDGETING
1. Estimate the cash flows
 2. Assess the risk of the cash flows
 3. Determine the appropriate discount rate.
 4. Find the PV of the expected cash flows.
 5. Apply proper evaluation criteria

7. Estimate the cash flows
 Initial Cash flow / Net investment
 Annual cash flow / Net cash flows
 Terminal cash flow

8. Net investment
Net Investment = Cost of New Project
+ Installation Costs
_ Proceeds From Sale or Disposal of
Assets
± Taxes on Sale of Assets

9. Annual cash flows / Net cash flow
Net cash flow = Earnings before depreciation and
taxes (EBIT)
- Depreciation
- Taxes
= Earnings after taxes (EAT)
+ Depreciation
= NCF

10. Project evaluation criteria
 Payback period
 Accounting Rate of Return (ARR)
 Net present value (NPV)
 Internal rate of return (IRR)
 Profitability index

11. Payback period
The payback period is defined as the time it
takes the cash inflows from a capital investment
project to equal the cash outflows, usually
expressed in years. When deciding between two
or more competing projects, the usual decision
is to accept the one with the shortest payback.

12. Accounting Rate of Return (ARR)
The ARR method (also called the return on capital
employed (ROCE) or the return on investment (ROI)
method) of appraising a capital project is to estimate
the accounting rate of return that the project should
yield. If it exceeds a target rate of return, the project
will be undertaken.

13. Net present value (NPV)
NPV = Total present value of all cash flows
- Initial investment
Decision rule:
If NPV is positive (+): accept the project
If NPV is negative(-): reject the project

14. Internal rate of return (IRR)
The IRR is the discount rate at which the NPV for a
project equals zero. This rate means that the present
value of the cash inflows for the project would equal
the present value of its outflows. The IRR is the
break-even discount rate. The IRR is found by trial
and error.

15. Relationship between NPV and IRR

16. Profitability Index (PI)
The profitability index, or PI, method compares the
present value of future cash inflows with the initial
investment on a relative basis. Therefore, the PI is
the ratio of the present value of cash flows (PVCF)
to the initial investment of the project.
investment
Initial
PVCF
PI 

17. MAKING GO/NO-GO PROJECT DECISION
 Focus on cash flow not profit
 Consider incremental cash flow
 Account for time
 Consider risk