This document discusses capital budgeting, which refers to the process of evaluating, selecting, and following up on capital expenditure projects. It describes various capital budgeting techniques for evaluating projects, including payback period, average rate of return, net present value, profitability index, and internal rate of return. These techniques analyze the costs and cash flows of projects to determine their potential profitability and acceptability. The document also outlines factors that must be considered in capital budgeting decisions and steps in the capital budgeting process.

2. It refers to the process of generating,
evaluating, selecting and following up of the
capital expenditure. This is called as Capital
Budgeting.
OTHER NAMES :-
 Capital expenditure decision
 Capital Expenditure management
 Long term Investment Decision
 Management fixedAssets

3.  Long-term Effect
 High degree of risk
 Huge funds
 Irreversible Decisions
 Most Difficult Decision
 Impact on cost Structure
 Impact on firm’s Competitive Strength

4.  Technology Change
 Competitor Strategy
 Demand Forecast
 Type of management
 Fiscal Policy
 Cash flows
 Return accepted from investment
 Economy Factor

5.  Profit Oriented Project
 New Project
 Expansion Project
 Replacement Project
 Research & Development Project
 Welfare Project
 Educational Project

6.  Generate
 Evaluate
 Selection
 Follow Up / Project Execution
 Performance Review

7.  Accept & Reject Decision-
 Mutually Exclusive Decision
 Capital Rationing Decision

8.  Cost and benefits of proposal-cash flow
 Required Rate of Return-cost of capital and cut of
rate
 Economic Life of the Project-unused life of project
 Available Funds-knowledge of internal and external
funds
 Risk Of obsolescence-expected losses
 Intangible Factor-goodwill

9. In capital budgeting decisions, the costs and benefits
of a proposal are measured in term of cash flows.
Cash flow refer to cash revenue means Cash
Expenses or Cash oriented measures of return
generated by a proposal .
 The Benefits are denoted Cash inflows
 The cost are denoted Cash outflows
NOTE
The Cash flow associated with a proposal usually
involve the following 3 types of Cash flow

10.  Initial Investment or Cash Outflows
 Net annual cash inflow
 Terminal Cash Inflow
(i) Initial Investment or Cash outflow
 Cost of new assets
 Opportunity Cost
 AdditionalWorking Capital

12. 1. PROFITABILITY STATEMENT (in revenue increasing decision)
NET CASH INFLOW= (SALES-EXPENSES-DEPRECIATION-TAX)+DEPRECIATION
OR
EBT-TAX+DEPRECIATION

13. 2. PROFITABILITY STATEMENT (in cost reduction decision)

14.  Estimated salvage or scrap value of the
project realisable at the end of the economic
life of the project or at the time of its
termination.
 Working Capital Released as the working
capital which was invested in the beginning
will no longer be required as the project is
being terminated.This working capital
released will be available back to the firm

15.  Traditional
I. Payback Period
II. Average Rate of Return
 Discounted Cash flow
I. Net present value
II. Profitability index
III. IRR-Internal rate of return

16.  Payback Period
The Payback Period is the length of the time
required to recover the initial cost of the project.
i. When annual Cash Inflow are equal
Where,
I =outlet/Investment/Outflow/Initial Investment
C= Net annual cash inflow

17. The Payback period is calculated by the process
of cumulative the cash inflow till the time
cumulative cash inflow equal to the initial
investment outlet.

18.  Post payback profitability
i. Total cash in life- Initial Loss
OR
Annual cash inflow ( total Life-Payback Period)

19.  This method is also knows as ‘Accounting rate of
return because the data required for its
calculation are drawn from Accounting Records.
it is also called ‘Un-adjusted rate of return
method ‘as it does not consider present value of
cash inflows. The average of return method is
used in order to measure the profitability of
investment proposals
 ARR means average annual earning on the
project. Under this method, profit after tax and
depreciation is considered.

20.  Under this method average annual profit
(after tax ) is expressed as percentage of
investment
Other name
 Return on investment
 Average rate of return
 Accounting rate of return method
 Un-adjusted rate of return method

22. AVERAGE INVESTMENT
ADDITIONALWORKING CAPITAL
Where,
SV= SalvageValue and NWC= NetWorking Capital

23.  The traditional methods of capital budgeting
are unable to consider the present value of
cash flows to be received in future from any
project i.e. time money is ignored. In capital
budgeting. All decisions about future are
taken at present, therefore, computation of
present value of future earnings to brings the
future at present level. These are also called
‘time adjusted rate of return’ or Discounted
cash flow’ or’ present value’ techniques.

24.  Net Present value method
 NPV Index Method
 Internal Rate of return method

25.  This technique of finding present value popularly
known as discounting which is opposite of
compounding or future value method .
 The present value of cash flows for different
years may be calculated either with the help of
following formula or ‘ Present valueTable”

26.  Net present value Method:- Net present value is
defined as the aggregate of present value of expected
inflows minus the tot present value of outflows where
the inflows and outflows are discounted for timing a
rate of discount equivalent to the cost of capital of the
firm.
 It is the best method for evaluation of investment
proposal. This method takes into account time value of
money.
present value - initial Outlet
Accept if NPV>0
REJECT NPV<0
May Or MAY NOT Accept NPV=0

27.  It is based on the concept of discounting the
future cash flows and is the ratio of present
value cash inflows discounted at an expected
rate of return to the initial cost of the
investment or present value of the future
outflows.

28.  Internal rate of return is a rate which actually
equates the present value of expected cash
inflows with the present value of expected cash
outflows.
 It is knows by several other names also areTime
Adjusted rate of return or marginal rate of
return or marginal efficiency of capital

29.  IRR is the rate of return that project earns.
The rate of discount calculated by trial and
error, where the present value of future cash
flow is equal to the present value of outflows,
is known as the internal Rate of Return.
 There may be of two types of cash inflows
(i) Even cash in flows (ii) uneven cash inflows

30.  EVEN CASH FLOW
STEP - I First of all rough approximation may
be made with reference to present value
factor(PV factor) or pay-back period
STEP- II Find out present value
PRESENTVALUE=ANNUAL CASH INFLOWS x P.V. FACTOR FOR AN ANNUITY

31.  STEP – III Find out exact IRR between the
two rates by interpolation

33.  UNEVEN CASH INFLOWS
In this case IRR is calculated byTrial and Error
method.
1. Establishing the firstTrial Rate –Calculate the P.V
factor
2. The secondTrial Rate- the total Cash inflow will
be compared with the first trial rate Present value
of cash inflow.
3. Computation of IRR-(Formula is given earlier in
case of even cash inflows)

34. 1. No accuracy of Estimates
2. Comparability of costs and benefits
3. Consideration of certain Costs and Benefits
CAPITAL EXPENDITURE CONTROL
1. Search for new methods, Processes and products
2. Comprehensive Planning
3. Use of capital Budgeting
4. Rational Evaluation
5. Progress Record
6. Post- Completion Audit

35. Thank you