This document discusses capital budgeting and its techniques. Capital budgeting is used to evaluate the viability of long-term investments. It examines techniques like average rate of return, payback period, net present value, profitability index, and internal rate of return. These techniques help determine whether to accept or reject an investment proposal based on factors like comparing returns to target rates, number of years to recover costs, discounted cash flows, and rates of return.

1. CAPITAL BUDGETING
AND
ITS TECHNIQUES
PRESENTED BY
Y.MADHU VENKATA SAINATH
171FC01085
Madhusainath.y2017@gmail.com

2. What is capital budgeting
Capital: it refers to funds raised to support a
particular business or project.
Budgeting: A Budget is a quantitative plan used
as a tool for deciding which activities will be
chosen for a future time.

3. Capital budgeting
• The Capital Budgeting Techniques are
employed to evaluate the viability of long-
term investments. The capital budgeting
decisions are one of the critical financial
decisions that relate to the selection of
investment proposal or the course of action
that will yield benefits in the future over the
lifetime of the project.

5. Average rate of return
ARR means the average annual earning on the project. Under
this method, profit after tax and depreciation is considered. It
is also called as return on capital employed method The
ARR is calculated as follows
ARR = Average profit after tax
Average investment
• ARR > TARGET RATE -ACCEPT THE PROPOSAL
• ARR < TARGET RATE - REJECT THE PROPOSAL
• ARR = TARGET RATE - FUTURE ANALYSIS IS REQUIRED

6. Pay back period
It is defined as the number of years required to recover original
cost invested in a project. It has two conditions.
When cash inflow is constant every year :
PBP= Cash outflow/cash inflow (p.a.)
• pbp > TARGET RATE -ACCEPT THE PROPOSAL
• pbp < TARGET RATE - REJECT THE PROPOSAL
• pbp = TARGET RATE - FUTURE ANALYSIS IS REQUIRED
o When cash inflow are not constant every year :
PBP = year before + Unrecovered amount
full recovery --------------------------
Cash flow during
the year

7. Net present value method
It is the best method for evaluation of
investment proposal. This method takes into
account time value of money.
NPV = Sum of discounted cash inflows – sum
of discounted Cash
outflows
Evaluation - Accept if NPV>0
Reject if NPV<0
May or may not accept if NPV=0

8. Profitability index
As the NPV method it also shows that project is
accepted or not. If Profitability index is higher
than 1, the proposal can be accepted.
P.I = Total cash inflows
Total cash outflows
Evaluation =ACCEPT if P.I>1
REJECT if P.I<1

9. Internal rate of return
IRR is the rate of return that a project earns. The
rate of discount calculated by trial and error ,
when the present value of future cash flows is
equal to the present value of outflows, is known
as the Internal Rate of Return.
IRR = Higher rate – NPV of higher rate
*difference In
difference in cash rate
flows