1.
Advance Financial Risk Management
Topic: Capital Budgeting
Submitted To: Mr. Kashif Abbas
Presented by:
1. Mr. Adnan Khan
2. Ms. Aneha Zahid
3. Ms. Quratulain
Program: MS Management Sciences
Session: 2022-24
Riphah International University, QIE Lahore

2.
(01). My name is Adnan khan and I would like
to Discuss the theory of Capital Budgeting.

3.
Outline
 Introduction
 Definition of Budget
 Budget sector and types of budget
 Capital Budgeting
 Importance of Capital Budgeting
 Pros and Cons of Capital Budgeting
 Capital Budgeting: Project Categorization
 Capital Budgeting: Eight Steps
 Duties of Financial Managers
 Evaluation Criteria: Capital investment Appraisals
 Non-Discounted and Discounted Cash Flow (DCF) Techniques
 Net Present Value (NPV)
 Internal Rate of Return (IRR)
 Profitability Index (PI)
 Summary and Conclusions

4.
Definition of Budget
• Budgeting is a management tool for planning and controlling future
activity.
• Financial Buzz Words: A plan for saving, borrowing and spending.
• A budget is a financial plan that includes a list of all anticipated costs
and income.

5.
Budget Sector:
Business start up Budget, Corporate/business budget, Government Budget, Event
management budget, Personal/Family budget.
Budget Types:
 Basis of Flexibility: fixed and variable budget.
 Basis of time period: short term and long term budget.
 Basis of functionality: Sales, production, market, project, revenue, Cash Flow
Budgets etc.

6.
Introduction
 Capital Budgeting is the process of determining which real investment
projects should be accepted and given an allocation of funds from the firm.
 It is crucial to assess how well capital budgeting procedures support the
objective of maximizing shareholder wealth.
 Capital budgeting is the planning process used to determine a firms long
term investments such as new machinery, replacement machinery, new
plants, new products and research and development projects.

7.
Capital Budgeting
• Capital:
Operating assets used for production.
• Budget:
A strategy that describes expected cash flows over a specific time period.
• Capital Budgeting:
The procedure of evaluating projects and selecting those to be included
in the capital budget.

8.
Importance of Capital budgeting:
• Capital budgeting helps financial decision-makers make informed financial
decisions for projects they expect to last a year or more that require a large
capital investment. Such projects can include:
• Investing in new equipment, technology and buildings
• Upgrading and maintaining existing equipment and technology
• Completing renovation projects on existing buildings
• Expanding their workforce
• Developing new products
• Expanding into new markets
• Growth
• Large Amount

9.
Pros and Cons of Capital Budgeting
• Helps in understanding risks and Its
effects.
• Decision making in investment
opportunities.
• Various Techniques of Capital budgeting.
• Making an informed decision considering
all possible factors.
• Choosing investments wisely.
• Increase shareholders wealth &
advantageous in the market.
• Adequate control over expenditure
• Abstains from over or under investing.
• Decisions are long-term & majorly
irreversible in nature.
• Uncertainty leads to wrong
applicability.
• Techniques are assumed & not real.
• Introspective in nature due to
subjective risk & discounting factor.
• Wrong decision affects long-term
durability.
• Availability of skilled professionals
is not easy.
• Expensive.

10.
Capital Budgeting: Project Categorization:
• Establishment of new products and Services.
• Replacement projects: Maintenance or cost reduction
• Expansion of existing projects
• Research and development projects
• Long term contracts
• Safety and environmental projects

11.
Eight Steps of Capital Budgeting

12.
Recall the Flows of a funds and decisions
important to the financial manager
Financial
Manager
Financial
Markets
Real Assets
Financing
Decision
Investment
Decision
Returns from Investment Returns to Security Holders
Reinvestment Refinancing
Capital Budgeting is used to make the Investment Decision

13.
The Three Primary Duties of the Financial
Manager
We make judgments based on the same broad principles whether we are
managing money for the family or the business. As we carry out those
three basic tasks, these principles teach us how to make decisions of
three different kinds:
 The capital budgeting decision
 The capital structure decision
 The working capital decision

14.
The Capital Budgeting Decision
The financial manager determines the optimal long-term location for money
deployment using the capital budgeting decision. While paying a utility bill is
not a capital budgeting choice, buying a new delivery truck or warehouse is.
With the making of this decision, we consider three features of the cash flows
deriving from the decision:
• The size of the cash flows
• The timing of the cash flows
• The risk of the cash flows

15.
The Capital Structure Decision
The financial manager chooses the capital structure in order to determine
where to get funds in the long run. A capital structure choice is whether to
pay cash for the new delivery truck or take out a loan from GMAC or Ford
Motor Credit. Another choice is whether to finance a franchise purchase
with long-term debt.
The most essential capital structure option is whether to finance a
company's expansion with debt or equity, such as money contributed by the
company's founders, angel investors, venture capitalists, or public stock
issues. This option has the following two merits to mention:
• The risk of the debt
• The founders' potential to get less money when their equity or stock is sold, as
well as a loss of control.

16.
The Working Capital Decision
 The financial manager's attention shifts to current assets and current
liabilities with the working capital decision.
 The short-term assets that make up one part of working capital include
things like cash balances, accounts receivable, inventory levels, and short-term
accruals (such prepaid rent or utilities).
 We consider short-term commitments, such as accounts payable to
vendors, and other debt that is anticipated to be repaid within a year when
making a working capital decision.
 A significant result of the working capital decision-making matrix is net
working capital. The gap between current assets and current liabilities is what
is known as net working capital.

17.
The Capital Budgeting Choice: Capital Budgeting
Decision-making Criteria
Remember that a capital budgeting decision is one that allocates business resources
over the long term with the goal of maximizing shareholder wealth.
How do we know when we are doing that?
We use four new tools to assist us:
• The Net Present Value or NPV rule in Section 8.1
• The Payback rule in Section 8.2
• The Internal Rate of Return or IRR rule in Section 8.4
• The Profitability Index in Section 8.5

18.
(02). My name is Aneha Zahid and I would like
to Discuss the Evaluation Criteria: Capital
Budgeting

19.
Evaluation Criteria: Capital Budgeting

20.
NPV: Strengths and Weaknesses
• Strengths
• Resulting number is easy to interpret: shows how wealth will change if the
project is accepted.
• Acceptance criteria is consistent with shareholder wealth maximization.
• Relatively straightforward to calculate
• Weaknesses
• Requires knowledge of finance to use.
• An improper NPV analysis may lead to the wrong choices of projects when
the firm has capital rationing – this will be discussed later.

21.
PI: Strengths and Weaknesses
• Strengths
• PI number is easy to interpret: shows how many $ (in PV terms) you get
back per $ invested.
• Acceptance criteria is generally consistent with shareholder wealth
maximization.
• Relatively straightforward to calculate.
• Useful when there is capital rationing (to be discussed later).
• Weaknesses
• Requires knowledge of finance to use.
• It is possible that PI cannot be used if the initial cash flow is an inflow.
• Method needs to be adjusted when there are mutually exclusive projects (to
be discussed later).

22.
IRR: Strengths and Weaknesses
• Strengths
– IRR number is easy to interpret: shows the return the project generates.
– Acceptance criteria is generally consistent with shareholder wealth
maximization.
• Weaknesses
– Requires knowledge of finance to use.
– Difficult to calculate – need financial calculator.
– It is possible that there exists no IRR or multiple IRRs for a project and
there are several special cases when the IRR analysis needs to be adjusted
in order to make a correct decision (these problems will be addressed
later).

23.
(03). My name is Quratulain and I would like to
Discuss the Computation of Methods.

24.
Summary and Conclusion
• We have studied evaluation criteria for Capital Budgeting like, NPV, IRR, and PI,
are all good techniques for capital budgeting and allow us to accept or reject
investment projects consistent with the goal of shareholder wealth maximization.
• Generally an impression created that the firm should use NPV method for Decision
Making.
• Beware, however, there are times when one technique’s output is better for some
decisions or when a technique has to be modified given certain circumstances.

25.
Thank
you