Capital Budgeting

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Capital Budgeting

  1. 1. NPV IRR PREMCHAND 12ME1E0020
  2. 2. “The term capital budgeting generally refers to acquiring inputs with long term returns” Richards & Greenlaw
  3. 3.  The finance function has to deal with one of the most important decisions regarding:  The amount to be invested in fixed assets.  The decision is technically in the form of “Capital Budgeting”
  4. 4. Generation Evaluation Selection Execution  Identification of investment proposals  Screening the proposals Evaluation of various proposals Fixing priorities Final Approroval Implementation of proposals Performance review
  5. 5. Accounting rAte of returns
  6. 6. Traditional Techniques
  7. 7.  Pay Back Period indicates the period within which the cost of the project will be completely recovered.  It indicates the period within which the total cash inflows equal to the total cash outflows.  Accept/Reject rules: ACCEPT : calculated PBP < standard PBP REJECT : calculated PBP > standard PBP CONSIDER : calculated PBP = standard PBP Year before fully recovered + unrecovered amt of investment  Pay Back Period = ------------------------------------------------- cash flows during the period of final recovery
  8. 8.  ARR is used to measure the profitability of investment proposals  ARR is computed by dividing the average profits after depreciation and taxes by net investments in the project.
  9. 9. MODERN TECHNIQUES
  10. 10.  Net Present Value is a method of calculating present value of each inflows and cash outflows in an investment project, by using cost of capital as the discounting rate.  Accept/reject Rule : ◦ NPV > 0 will be accepted ◦ NPV < 0 will be accepted ◦ NPV = 0 will be consider NPV = Discounted Cash Inflows – Discounted Cash Outflows
  11. 11.  Internal Rate of Return (IRR) is that rate at which the discounted cash inflows match with discounted cash outflows.  Thus IRR may be called as the “break even rate” of borrowing for the company.  In simple words IRR indicates that discounting rate at which NPV is zero.  IRR > Cost of Capital ---- Accept  IRR < Cost of Capital -----Reject  IRR = Cost of Capital -----Consider
  12. 12.  It is the ratio between total discounted cash inflows and total discounted cash outflows. Thus profitability index can be computed as follows.  Acceptance Rule  PI > 1 will be accepted  PI < 1 will be reject  PI = 1 will be consider
  13. 13.  It is also called as PROFITABILITY INDEX  The excess present value index is calculated by dividing the net present value of cash inflow by initial net investment cost PV of cash inflow Pay Back Period = ------------------------------------- Initial cash out lay
  14. 14. Thank You K PREMCHAND 12ME1E0020

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