BBA

1. DISCOVER . LEARN . EMPOWER
Subject Code
21BAT-265
(BBA-Semester IV)
Topic:-Traditional Methods of Capital Budgeting
Faculty Name-Vivek Sharma(E13500)

2. 2
Co
No
Title Level
CO4
To evaluate long-term investment decisions
using Modern Theories and Traditional
Theories of cost and dividend.
Evaluate
Covered Course Outcome
Traditional Methods of Capital Budgeting
Course Objectives
. To have an understanding of important financial
concepts and analytical tools used in the financial
decision-making process

3. Learning
Outcomes
1. Pay-Back Period Method
2.Improvement in Traditional
Approach Methods
3.Accounting Rate of Return
Method

5. SOME BASIC CONCEPTS
• Book Profit VS Cash Flow:
• Book Profit: It is also known as accounting profit.
• Net Profits after Taxes
• Cash Flow: It is focused on cash inflow and outflow
and ignores all non-cash activities
• Net Profits after taxes but before depreciation

6. HOW TO CALCULATE
ANNUAL CASH INFLOWS(ACF)
• ACF means Net Profits After Taxes and Before Deptrciation.
• Thus in case Net Profits After Taxes are given Depreciation
needs to be added back.

7. PAY-BACK PERIOD METHOD
• The ‘Pay back’ sometimes called as payout or pay-off period
method represents the period in which the total investment in
permanent assets pays back itself.
• This method is based on the principle that every capital
expenditure pays itself back within a certain period out of
the additional earnings generated from the capital assets.
Thus, it measures the period of time for the original cost of a
project to be recovered from the additional earnings of the
project itself.

8. • Under this method, various investments are ranked according to
the length of their payback period in such a manner that the
investment with a shorter payback period is preferred to the
one which has a longer payback period.
• Formula:
• Pay Back Period Method will be calculated as follows
• Cash Outlay or Original Cost of the project/Annual Cash
Inflows

9. EXAMPLE 1

10. EXAMPLE 2

11. IMPROVEMENT OF TRADITIONAL APPROACH
TO PAY BACK PERIOD METHOD
• It will include the following four methods:
• a)Post Pay back profitability
• b)Pay-back Reciprocal Method
• c)Post Pay-back Period Method
• d)Discounted Pay-back Method

12.  Post Payback Period Method. One of the limitations of the pay–back period method
is that it ignores the life of the project beyond the pay–back period. Post Pay–
back Period method takes into account the period beyond the pay–back
method. This method is also known as Surplus Life over Pay–back method.
According to this method, the project which gives the greatest post pay–back
period may be accepted. The method can be employed successfully where the
various projects under consideration do not differ significantly as to their size
and the expected cash inflows are even throughout the life of the project.

13. Discounted Pay–back Method
• Under this method the Present Value of all cash outflows and inflows are
computed at an appropriate discount rate. The present values of all inflows
are cumulated in order of time.
• The time period at which the cumulated present value of cash inflows
equals the present value of cash outflows is known as discounted pay–back
period. The project which gives a shorter discounted pay–back period is
accepted.

14. EXAMPLE 4

15. RATE OF RETURN METHOD
• In this method concept of Book Profits is used i.e. Net Profits After Taxes.
• It is known as the Accounting Rate of Return method for the reason that under this
method, the Accounting concept of profit (net profit after tax and depreciation) is used
rather than cash inflows.
• According to this method, various projects are ranked in order of the rate of earnings or
rate of return. The project with the higher rate of return is selected as compared to the
one with a lower rate of return.

16. EXAMPLE 3

17. THE RETURN ON INVESTMENT METHOD CAN BE
USED IN SEVERAL WAYS.

19. TIME–ADJUSTED OR DISCOUNTED CASH FLOW
METHODS
The traditional methods of capital budgeting i.e. payback method as well as the accounting
rate of return method, suffer from serious limitations that give equal weight to the present
and future flow of incomes. These methods do not take into consideration the time value of
money, the fact that a rupee earned today has more value than a rupee earned after five
years. The time–adjusted or discounted cash flow methods take into account the
profitability and also the time value of money. These methods also called modern methods
of capital budgeting are becoming increasingly popular day by day.

20. LIMITATIONS OF CAPITAL BUDGETING
DECISIONS
1. All the techniques of capital budgeting presume that various investment proposals under
consideration are mutually exclusive which may not practically be true.
2. The techniques require estimation of future cash inflows and outflows. The future is
always uncertain and the data collected for future may not be exact.
3. There are certain factors like morale of the employees, goodwill of the firm, etc., which
cannot be correctly quantified but which other wise substantially influence the capital
decision.

21. PRACTICE PROBLEMS

22. APPLICATION
• The concepts discussed in this unit will help in the following:-
• Field of Investment Banking
• Personal Financial Planning
• Area of Budgetary Control
• In the area of Risk Management by doing credit analysis

23. • Textbooks / Reference Books
•
1. Chandra, Prasanna “Financial Management”, Tata McGraw Hill, New Delhi
2. Khan M.Y. & Jain P.K, Financial Management, Tata McGraw Hill, New Delhi
3. Pandey I.M “Financial Management”, Vikas Publishing House, New Delhi
4. Shashi, K. Gupta “Financial Management”, Kalyani Publishers.
5. Rustagi, R.P “Financial Management”, Taxmann’s Publications
• Web links for relevant reading material-
• https://www.taxmann.com/post/blog/what-is-capital-budgeting-financial-management/
• https://www.businessmanagementideas.com/financial-management/capital-budgeting/capital-budgeting-methods/22127

24. THANK YOU
For any queries
Kindly E-mail
vivek.e13500@cumail.in