Capital Budgeting Er. S Sood

Capital Budgeting Er. SS POWER GP.

Capital Budgeting : # The process of making investment decision in capital expenditures. # The planning for purchases of long- term assets. ,[object Object],[object Object]

Examples of Capital Expenditure: ,[object Object],[object Object],[object Object],[object Object]

Need and Importance CB ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

CB Process ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

CB Decisions ,[object Object],[object Object],[object Object]

Project Classification ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],[object Object],[object Object],[object Object]

Decision-making Criteria in Capital Budgeting ,[object Object]

[object Object],[object Object],[object Object],[object Object],Decision-making Criteria in Capital Budgeting

Methods / Techniques of CB Traditional Methods Time adjusted or discounted Methods ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

1. Payback Period ,[object Object],[object Object]

Payback Period Payback period = 3.33 years. Pay Back period = Original cost of the project Annual Cash Inflows CI = PAT + Dep 0 1 2 3 4 5 8 6 7 (500) 150 150 150 150 150 150 150 150

[object Object],[object Object],[object Object],[object Object],[object Object],Payback Period

Drawbacks of Payback Period ,[object Object],[object Object],[object Object],[object Object]

Drawbacks of Payback Period ,[object Object],[object Object],0 1 2 3 4 5 8 6 7 (500) 150 150 150 150 150 (300) 0 0

2. Improvement over the Pay back period method ,[object Object],[object Object],ii) Post pay back profitability index = Post pay back profits *100 Investments iii) Pay back reciprocal method = Annual cash inflows Total investment

iv) Discounted payback method ,[object Object],[object Object],[object Object],[object Object],[object Object]

Discounted payback method ,[object Object],[object Object],[object Object],[object Object],[object Object],0 1 2 3 4 5 ( 500) 250 250 250 250 250

Discounted payback method ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],0 1 2 3 4 5 ( 500) 250 250 250 250 250

Discounted payback method ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],0 1 2 3 4 5 (500) 250 250 250 250 250 The Discounted Payback is 2.52 years

3 . Accounting rate of return method -ARR ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

B. Time adjusted / discounted methods ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

1. Net Present Value ,[object Object],[object Object],NPV = - IO FCF t (1 + k) t n t=1 

Net Present Value ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

[object Object],NPV Example 0 1 2 3 4 5 (250,000) 100,000 100,000 100,000 100,000 100,000

Net Present Value (NPV) ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

2. Internal Rate of Return (IRR) ,[object Object],The rate at which PV CI =PV CO n t=1  IRR: = IO FCF t (1 + IRR) t

Internal Rate of Return (IRR) ,[object Object],[object Object],n t=1  IRR: = IO FCF t (1 + IRR) t

Calculating IRR ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

b) When cash inflows are not equal over the life of the asset: ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

IRR = LR + PV LR - I PV LR - PV HR * Difference between two rates IRR

Calculating IRR ,[object Object],[object Object],IRR =28% appox. 0 1 2 3 4 5 (250,000) 100,000 100,000 100,000 100,000 100,000

IRR ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Modified Internal Rate of Return - MIRR ,[object Object],[object Object]

MIRR Steps: ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

MIRR ,[object Object],[object Object],[object Object],[object Object],[object Object],0 1 2 3 4 5 (900) 300 400 400 500 600

MIRR ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

3. Profitability Index PI = PV CI PV CO PI = IO FCF t (1 + k) n t=1  t

[object Object],[object Object],[object Object],Profitability Index

Example of PI ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Factors affecting CB decisions ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Risk & uncertainty in CB ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Methods for ascertaining risk & uncertainty in CB ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Method of appraisal & their rationale ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Capital Budgeting Er. S Sood

Capital Budgeting Er. S Sood

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