This document discusses various capital budgeting techniques used to evaluate project proposals before adoption. It describes non-discounting techniques like payback period and accounting rate of return that do not consider time value of money. It also describes discounting techniques like net present value and internal rate of return that discount cash flows to account for time value. Formulas for calculating each technique are provided along with examples to illustrate their use in investment decision making.

1. PROJECT
INVESTMENT CRITERIA

2.  BEFORE ADOPTING ANY PROJECT
IT SHOULD BE SCRUNIZED TO
CHECK ITS FINANCIAL VIABILITY.
FOR THIS ,VARIOUS CAPITAL
BUDGETING TECHNIQUES ARE
USED TO EVALUATE PROJECT
PROPOSALS.

3. TECHNIQUES
INVESTMENT CRITERIA
NON DISCOUNTING DISCOUNTING
PAY BACK PERIOD NET PRESENT VALUE
ACCOUNTING RATE OF
RETURN IRR

4. NON DISCOUNTING CRITERIA
THESE TECHNIQUES DONOT CONSIDER THE TIME
VALUE OF MONEY(DISCOUNT RATE) TO FIND OUT
THEIR PRESENT WORTH.
IT INCLUDES TWO METHODS:
1) PAY BACK PERIOD METHOD.
2) ACCOUNTING RATE OF RETURN.

5. PAY BACK PERIOD
 THIS METHOD IS POPULARLY KNOWN AS PAY
OFF, PAY OUT, OR REPLACEMENT PERIOD METHOD.
IT REPRESENTS NUMBER OF YEARS REQUIRED TO
RECOVER THE ORIGINAL CASH OUTLAY INVESTED IN
A PROJECT.
FORMULA:
PAYBACK PERIOD = ORIGINAL COST OF PROJECT
ANNUAL CASH INFLOWS

6. EXAMPLE:
 Number of years needed to recover your initial outlay.
P R O J E C T P R O J E C T
Time A B Time A B
0 (10,000.) (10,000.) 0 (10,000.) (10,000.)
1 3,500 500 1 3,500 500
2 3,500 500 2 3,500 500
3 3,500 4,600 3 3,500 4,600
4 3,500 10,000 4 3,500 10,000
0 1 2 3 4
(10,000) 3,500 3,500 3,500 3,500
Cumulative -6,500 -3,000 +500
CF
(10,000) 500 500 4,600 10,000
Cumulative -9,500 -9,000 -4,400 +5,600
CF

7. ACOUNTING RATE OF RETURN
 THIS METHOD TAKES INTO ACCOUNT THE
EARNINGS EXPECTED FROM THE INVESTMENT
OVER THEIR WHOLE LIFE.
 IT IS KNOWN AS ARR METHOD FOR REASON
THAT UNDER THIS METHOD THE ACCOUNTING
CONCEPT OF PROFIT(NET PROFIT AFTER TAX AND
DEPRICIATION) IS USED RATHER THAN CASH
INFLOWS.
 THE PROJECTS WITH HIGHER RATE OF RETURN
IS SELECTED AS COMPARED TO THE ONE WITH
LOWER RATE OF RETURN.

8. FORMULA:
ARR = AVERAGE ANNUAL PROFIT
NET INVESTMENT IN PROJECT * 100
EXAMPLE:
INITIAL INVESTMENT= RS. 500000.
SCRAP VALUE = RS 20000. TIME= 5YEARS
PROFITS = RS.(40000, 60000, 70000, 50000, 20000).
CALCULATE ARR.
SOLUTION:
TOTAL PROFIT= RS.(40000+60000+70000+50000+20000)=
RS.2.40L
AVG.PROFIT = 240000 / 5 = RS.48000
NET INVESTMENT= INITIAL INVESTMENT – SCRAP VALUE
RS.( 500000 – 20000) = RS 480000
ARR = 48000 / 480000 * 100 = 10%

9. DISCOUNTING CRITIERIA
THE TIME ADJUSTED OR DISCOUNTED CASH FLOW
METHOD TAKE INTO ACCOUNT THE PROFITABILITY AND
ALSO THE TIME VALE OF MONEY.
 IT BELIEVE THE FACT THAT A RUPEE EARNED TODAY
HAS MORE VALUE THAN A RUPEE EARNED AFTER
5YEARS.
THESE METHODS ALSO CALLED MODERN METHODS.
IT INCLUDES TWO METHODS:
1) NET PRESENT VALUE METHOD.
2) IRR (INTERNAL RATE OF RETURN).

10. NPV(NET PRESENT VALUE) METHOD
 THIS METHOD TAKES INTO CONSIDERATION THE
TIME VALUE OF MONEY AND ATTEMPTS TO
CALCULATE THE RETURN ON INVESTMENT BY
INTRODUCING THE FACTOR OF TIME ELEMENT. THE
PRESENT VALUE OF RUPEE 1 DUE IN ANY NO. OF
YEARS CAN BE FOUND WITH THE USE OF
FOLLOWING FORMULA:
1 PV = PRESENT VALUE,
PV =
(1 + r) n r= RATE OF INTEREST,
n= NUMBER OF YEARS
ACCEPT / REJECT CRITIERIA OF A PROJECT :
WHERE NPV > 0 ACCEPT THE
PROPOSAL
NPV < 0 REJECT THE
PROPOSAL

11. NPV = PV of Inflows - Initial Outlay
P R O J E C T
Net Present Value Time A
Example:- 0 (10,000.)
1 500
2 500
k=10% 3 4,600
4 10,000
0 1 2 3 4
(10,000) 500 500 4,600 10,000
$500
455 (1.10) $500
413 (1.10) 2
$4,600
3,456 (1.10) 3 $10,000
(1.10) 4
6,830

12. 455
413
Rs.1,154 = NPV
3,456
6,830
Rs.11,154
PV Benefits > PV Costs NPV > $0
$11,154 > $ 10,000
ACCEPT THE
PROJECT

13. IRR(INTERNAL RATE OF RETURN)
 IN IRR METHOD THE CASH FLOWS OF A PROJECT
ARE DISCOUNTED AT A SUITABLE RATE BY HIT AND
TRAIL METHOD.WHICH EQUATE THE NET PRESENT
VALUE SO CALCULATED TO THE AMOUNT OF THE
INVESTMENT.
 UNDER THIS METHOD THE DISCOUNT RATE IS
DETERMINED INTERNALLY SO THIS METHOD IS
CALLED AS INTERNAL RATE OF RETURN.
FORMULA:
A1 + A2 + ………………………… + An
C=
(1+r) (1+r)2 (1+r)n

14. Internal Rate of Return Example:-
500 500 4,600 10,000
10,000 =
(1+ IRR ) (1+ IRR )2 (1+ IRR )3 (1+ IRR )4
Cannot solve for IRR directly, must use Trial & Error
TRY 14%
10,000 = 500 500 4,600 10,000
(1+ .14 ) (1+ .14)2 (1+ .14 )3 (1+ .14 )4
10,000 = 9,849 PV of Inflows too low, try lower rate
TRY 13%
10,000 = 500 500 4,600 10,000
(1+ .13 ) (1+ .13)2 (1+ .13 )3 (1+ .13 )4
10,000 = 10,155 13% < IRR < 14%

15. THANK YOU