This document defines and discusses various aspects of capital budgeting. It begins by defining capital budgeting and listing its importance, which includes maximizing shareholder value and minimizing costs. It then discusses different capital structure patterns involving equity, preference shares, and debt. The document concludes by explaining several techniques used for capital budgeting, such as net present value, profitability index, internal rate of return, payback period, and accounting rate of return. Formulas for calculating each technique are provided.

1. S.Nandhini
I MBA

2. Overview
 Meaning of capital budgeting
 Definition of capital budgeting
 Importance of capital budgeting
 Types of capital budgeting.

3. Meaning of capital budgeting

4. Definition

5. Importance
Value maximization: Maximizes the market value of
the firm(share value of the firm).
Cost minimization: it minimizes the cost of capital and
cost of financing.
Increase in share price: capital structure maximizes
the company’s market share by increasing the
earnings per share of the ordinary shareholders.
Investing opportunity: Capital structure increases the
ability of the copany to fund new wealth –increases the
investing opportunities.

6. Complex capital structure pattern
 Equity shares and debentures (i.e. long
term debt including bonds etc.)
Equity shares and preference shares.
Equity shares, preference shares and
debentures (i.e. long term debt including
bonds, etc).

7. Techniques used
Many formal methods are used in capital
budgeting , including the techniques such
as:
 Net present value.
 Profitability index.
 Internal rate of return.
 Payback period.
 Accounting rate of return.

8. Net present value
It is the difference between present value of
cash inflows and the present value of cash
outflows.
NPV= 𝑡=1
𝑇 𝐶 𝑡
(1+𝑟) 𝑡 − 𝐶0
𝐶𝑡 = net cash inflows during the period‘t’
𝐶0 = total initial investment costs.
r = discount rate.
t = number of time period

9. Profitability index
It is an investment appraisal technique calculated by dividing
the present value of future cash flows of a project by initial
investment required for the project.
Profitability index =
𝒑𝒓𝒆𝒔𝒆𝒏𝒕 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒇𝒖𝒕𝒖𝒓𝒆 𝒄𝒂𝒔𝒉 𝒇𝒍𝒐𝒘𝒔
𝒊𝒏𝒊𝒕𝒊𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝒓𝒆𝒒𝒖𝒊𝒓𝒆𝒅

10. Internal rate of return
It is the discount rate that causes the net present value
of future cash flows from an equal investment equal to
zero.
𝑰𝒏𝒕𝒆𝒓𝒏𝒂𝒍 𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏 = 𝑹 𝟏 +
𝑵𝑷𝑽𝟏 × (𝑹 𝟐− 𝑹 𝟏)
𝑵𝑷𝑽𝟏 − 𝑵𝑷𝑽𝟐
𝑹 𝟏= Low discount rate
𝑹 𝟐= higher discount rate.
NPV1= Higher net present value
NPV2 = Lower net present value

11. PAYBACK PERIOD
It is the time in which the initial cash outflow of an
investment is expected to be covered from the cash
inflows generated bu the investment.
Payback period =
𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘 𝒑𝒆𝒓 𝑷𝒆𝒓𝒊𝒐𝒅

12. Accounting rate of return
It is ratio of estimated accounting profit of a project to the
average investment made in the project.
Accounting rate of return =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕