investment decision or capital budgeting for C.A , C.W.A and M.COM /M.B.A students

2. The long term investment decisions of a firm are
generally known as the capital budgeting, or capital
expenditure decisions .It includes
expansion
acquisition,
 modernization
replacement of the long-term assets
disinvestment / sale of a plant or branch
change in the-
 research and development programme
 methods of sales distribution

3. Involve massive investment
The exchange of current funds for future benefits
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series
of years.
Involves uncertainty and risk for the firm .

4. Growth
Risk
Funding
Irreversibility
Complexity

5. IT SHOULD-
maximize the shareholders’ wealth
consider all cash flows to determine the true profitability
of the project.
help ranking of projects according to their true
profitability.
recognize the fact that bigger cash flows are preferable to
smaller ones and early cash flows are preferable to later
ones.
 help to choose among mutually exclusive projects that
project which maximizes the shareholders’ wealth.

6. ON THE BASIS OF EXPENSION
Expansion of existing business
Expansion of new business
Replacement and modernization
ON THE BASIC OF DEPENDENCY
Mutually exclusive investments
Independent investments
Contingent investments

7. Discounted Cash Flow
Net Present Value (NPV)
Internal Rate of Return (IRR)
Profitability Index (PI)
Non-discounted Cash Flow
Payback Period (PB)
Discounted Payback Period (DPB)
Accounting Rate of Return (ARR)

8. Net present value can be find by subtracting present
value of cash outflows from present value of cash
inflows.
WHERE
 C1 =cash inflow for period 1,2,3,4,……n
 K = discounting rate
 Co = cash outflow

9. NPV > 0 ; accepted
NPV< 0 ; reject
NPV = 0 ; May accept
In case of mutually exclusive projects the one with the
higher NPV should be selected.

10. The internal rate of return (IRR) is the rate that
equates the investment outlay with the present value
of cash inflow received after one period.

11. Uneven Cash Flows: (Calculating IRR by Trial and Error)
 select any discount rate to compute the present value of cash
inflows .
 If the calculated present value of
 inflow < present value of cash outflows = A lower rate should try
 inflow > present value of cash outflows = A higher rate should try
 This process will be repeated unless the net present value
becomes zero.

12. IRR > K ; accepted
IRR< K ; reject
IRR = K ; May accept
In case of mutually exclusive projects the one with the
higher IRR should be selected.

13. ratio of the present value of cash inflows, at the
required rate of return, to the initial cash outflow of
the investment.

14. PI > 1 ; accepted
PI< 1 ; reject
PI = 1 ; May accept
In case of mutually exclusive projects the one with the
higher PI should be selected.

15. Payback is the number of years required to recover the
original cash outlay invested in a project.
 Payback =INITIAL INVESTMENT
ANNUAL CASH INFLOW

16. The project would be accepted if its payback period is
less than the maximum or standard payback period
set by management.
In case of mutually exclusive projects the one with the
Lowest payback period should be selected.

17. The discounted payback periods the number of
periods taken in recovering the investment outlay on
the present value basis.

18. The accounting rate of return is the ratio of the average
profit after-tax and average investment.
OR
ratio of the average profit after-tax and original cost
investment .
Average income
Average investment
ARR =

19. The project would be accepted if its ARR is higher
than the maximum or ARR set by management.
Rank a project as number one if it has highest ARR
and lowest rank would be assigned to the project with
lowest ARR.