Capital Budgeting

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capital budgeting

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Capital Budgeting

  1. 1. Capital Budgeting Course Teacher M. Zahangir Alam Lecturer in Finance IIUC - DC
  2. 2. Concept of Capital Budgeting <ul><li>The process of identifying, analyzing, and selecting investment projects whose returns (cash flows) are expected to extend beyond one year. </li></ul>Should we build this plant?
  3. 3. Significance of Capital Budgeting <ul><li>To influence the firm’s growth in the long run. </li></ul><ul><li>To affect the risk of the firm. </li></ul><ul><li>To involve huge amount of funds. </li></ul><ul><li>It can not easily be changed without considerable financial loss. </li></ul>
  4. 4. The Capital Budgeting Process <ul><li>Select projects based on a value-maximizing acceptance criterion. </li></ul><ul><li>Re-evaluate implemented investment projects continuously and perform post audits for completed projects. </li></ul>
  5. 5. Classification of Investment Project Proposals <ul><li>New Products or expansion of existing products. </li></ul><ul><li>Replacement of existing equipment or buildings. </li></ul><ul><li>Research and development. </li></ul><ul><li>Exploration. </li></ul><ul><li>Other (e.g., safety or pollution related) </li></ul>
  6. 6. Types of Project <ul><li>Independent Project: The acceptance the one project’s does not eliminate the acceptance of others. </li></ul><ul><li>Mutually Exclusive Project : The acceptance the one project’s eliminates the acceptance of others. </li></ul>
  7. 7. Techniques of Capital Budgeting <ul><li>Pay Back Period (PBP): It refers to the number of years required to recover the initial investment in the form of cumulative cash inflows. </li></ul><ul><li>Decision Criterion: </li></ul><ul><li>If actual PBP is less than standard PBP accept the project and vice versa. </li></ul>
  8. 8. <ul><li>Net Present Value (NPV): It is one of the capital budgeting techniques, recognizing the time value of money. </li></ul><ul><li>Decision Criterion: </li></ul><ul><li>If NPV is greater than zero accept the project and vice versa. </li></ul>
  9. 9. <ul><li>Internal Rate of Return (IRR): The discount rate of a project which makes it NPV equal to zero. </li></ul><ul><li>Decision Criterion: </li></ul><ul><li>Accept the project if IRR is greater than cost of capital and vice versa. </li></ul>

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