The document discusses capital budgeting, which refers to the process of evaluating long-term investment projects. It describes the various techniques used to evaluate capital budgeting proposals, including non-discounting methods like payback period and accounting rate of return, as well as discounted cash flow methods like net present value, internal rate of return, and profitability index. The stages of the capital budgeting process and sources of financing for capital budgeting decisions are also outlined.

1. CAPITAL BUDGETING

2. • AGENDA :
1) Capital Budgeting
2)Capital Budgeting process
3) Techniques of capital Budgeting
4) The cost of capital
5) Capital Budgeting extensions

3.  Capital budgeting is the process of evaluating and selecting long
term investments that are consistent with the goal of shareholders
(owners ) wealth maximisation .
 Capital budgeting is the planning process used to determine a firms
long term investments . Such as new machinery , replacement
machinery, new products , R&D projects .
 Capital expenditure is an outlay of funds that is expected to
produce benefits over a period of time exceeding one year These
benefits may be either in the form of increased revenues or reduced
costs .
 The term capital budgeting is otherwise called as
investment appraisal .

4. • Sources of financing capital Budgeting Decision / Project finance :
Capital budgeting decisions are financed using long term sources .
The various types of long term sources are :
• Equity capital ( Equity shares or ordinary shares )
• Hybrid capital ( preference shares )
• Debit capital ( Debentures / Bonds and Term loans )

5. • Stages of Capital Budgeting process :
Planning
Analysis : 1) Market analysis
2) Technical analysis
3) Financial analysis
4) Economic analysis
5) Ecological analysis
Selection
Implementation
Review

6. Capital Budgeting Evaluation Techniques
Non –discounting techniques Discounting techniques
Ignores the time value of money Considers the time value of money
3) Average Rate Return /Accounting 3) Net present value (NPV)
rate of return (ARR) 2) Internal Rate of Return (IRR)
2) Pay back period (PBP) 3) Profit index or Benefit –cost
Ratio (BCR)

7. Pay Back period : PBP is used as a first screening method , it gives
an indication of rough measure of liquidity . Under this method
accumulation of cash flows is made year after year until it meets the
initial capital outlay ,to identify the recovery time of the capital
amount invested.
PBP = Initial investment
Annual cash in flow
1) If PBP > Target period – Accept the proposal
2) If PBP < Target period – Reject the proposal
3) If PBP = Target period -- Further analysis is required
* Target period is the minimum period targeted by management to
cover initial investment .

8. • ARR : Average Rate of Return :
Average rate of return also known as accounting rate of return is
defined as average cash inflows (Benefits) against unit investment
ARR = Average cash inflows (Benefits ) * 100
Initial investment
1) If ARR > Target rate – Accept the proposal
2) If ARR < Target rate – Reject the proposal
3) If ARR = Target rate – Further analysis is required
* Target rate is the minimum rate of return targeted by management
ARR is otherwise called as return on capital employed method .

9. Discounting techniques :
Under discounted cash flow techniques, the future net cash flows generated
by a capital project are discounted to ascertain their present values .
NPV: Net present value :
Under NPV method future cash flows are discounted at minimum required
rate of return of the project and then deduct it from initial out lay to arrive at
the NPV of the project .
NPV = PV (Benefits) – Initial investment
1) Accept if NPV > 0
2) Reject if NPV < 0
3) May accept or Reject if NPV = 0
n Ct
Net Present Value = ∑ ---------t - C0
t=1 (1+k)

10. • IRR : Internal rate of return :
IRR is a percentage discount rate used in capital investment
appraisals which equates the present value of anticipated cash
inflows with initial capital outlay . It is that discount rate at which
NPV = 0 . Discount rate is ascertained by trail and error method .
C 0 = C 1 + C 2 + C 3 + ….. C n
(1+r) (1+r) 2 (1+r) 3 (1+r) n
1) Accept IRR > K
2) Reject IRR < K
3) May accept or Reject if IRR = K

11. Profitability index :
The profitability index is the present value of an anticipated cash in
flows divided by the initial investment . It is a method of assessing
capital expenditure opportunities in the profitability index .
Profitability index (pi) = Present value of cash inflows
Present value of cash out flows
This method is also called cost benefit ratio or desirability ratio