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    Capital Budgeting: Presenting by

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    muhammad usama
    The document discusses capital budgeting, which is the process of evaluating long-term investments. It outlines the capital budgeting process and various techniques used to analyze investments, including non-discounting methods like payback period and accounting rate of return, as well as discounting methods like net present value, internal rate of return, and profitability index. An example calculation is provided to illustrate how to use these techniques to evaluate a potential capital project.

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    Capital Budgeting: Presenting by

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    muhammad usama
    43 views18 pages
    The document discusses capital budgeting, which is the process of evaluating long-term investments. It outlines the capital budgeting process and various techniques used to analyze investments, including non-discounting methods like payback period and accounting rate of return, as well as discounting methods like net present value, internal rate of return, and profitability index. An example calculation is provided to illustrate how to use these techniques to evaluate a potential capital project.

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    The document discusses capital budgeting, which is the process of evaluating long-term investments. It outlines the capital budgeting process and various techniques used to analyze investments, including non-discounting methods like payback period and accounting rate of return, as well as discounting methods like net present value, internal rate of return, and profitability index. An example calculation is provided to illustrate how to use these techniques to evaluate a potential capital project.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    43 views18 pages

    Capital Budgeting: Presenting by

    Uploaded by

    muhammad usama
    The document discusses capital budgeting, which is the process of evaluating long-term investments. It outlines the capital budgeting process and various techniques used to analyze investments, including non-discounting methods like payback period and accounting rate of return, as well as discounting methods like net present value, internal rate of return, and profitability index. An example calculation is provided to illustrate how to use these techniques to evaluate a potential capital project.

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    © All Rights Reserved
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    Download as pptx, pdf, or txt
    of 18

    CAPITAL BUDGETING

    PRESENTING BY:
    MUHAMMAD AZEEM
    SYED ASIM HUSSAIN
    ISMAIL TARIQ

    PRESENTING TO: SIR ASIF NAJI


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

     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 .
    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 )
    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
    Capital Budgeting Evaluation Techniques

    Non –discounting techniques: Discounting techniques

    Ignores the time value of Considers the time value of


    money money

    Average Rate Return / Net present value (NPV)


    Accounting rate of return (ARR)
    Internal Rate of Return (IRR)
    Pay back period (PBP)
    Profit index or Benefit –cost
    Ratio (BCR)
    Pay Back period :
    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 .
    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 .
    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 :


     UnderNPV 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 - C
    Net Present Value = ∑ ---------t 0
    t=1 (1+k)
    IRR : Internal rate of return :
    • 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
    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
    Example
    The expected cash flows of a project are:-
    Year Cash Flows ( Rs.)
    1 20,000
    2 30,000
    3 40,000
    4 50,000
    5 30,000
    The cash outflow is Rs. 1,00,000
    The cost of capital is 10%
    Calculate the following:
    a) NPV b) Profitability Index
    c) IRR
    d) Pay-back period e) Discounted Pay-back Period
    Computation of NPV and PI
    Year Cash Flows (Rs.) PV Factors@10% PV of Cash Flows (Rs.)

    1 Computation
    20,000 of
    .909NPV & PI 18,180
    2 30,000 .826 24,780
    3 40,000 .751 30,040
    4 50,000 .683 34,150
    5 30,000 .620 18,600
    Total Cash Inflow 1,25,750
    Less: Cash 1,00,000
    Outflows
    NPV 25,750
    P.I. 1.2575
    Computation of IRR
    Year Cash PV Factors PV of Cash PV Factors PV of Cash
    Flows (Rs.) @19% Flows (Rs.) @18% Flows (Rs.)

    1
    Com
    20,000
    p utation
    .84
    of NPV
    16,800
    &
    .847
    PI 16,940
    2 30,000 .706 21,180 .718 21,540
    3 40,000 .593 23,720 .609 24,360
    4 50,000 .499 24,950 .516 25,800
    5 30,000 .42 12,600 .437 13,110
    Total Cash Inflow 99,250 1,01,750
    Less Cash Outflows 1,00,000 1,00,000

    NPV (-)750 (+)1750


    Computation of IRR Contd..
    Computation of non discounting pay-back period
    Year Cash Flows (Rs.) Cumulative Cash Flow

    1 20,000 20,000
    2 30,000 50,000
    3 40,000 90,000
    4 50,000 1,40,000
    5 30,000 1,70,000

    Completed years + Required inflow *12


    PBP = Inflow of Next year

    = 3years+ (1,00,000-90,000) *12


    50,000
    = 5.4 years
    Computation of discounted pay-back period
    Year Cash Flows PV PV of Cash Cumulative
    (Rs.) Factors@10% Flows (Rs.) Cash Flows
    1 20,000 .909 18,180 18,180
    2 30,000 .826 24,780 42,960
    3 40,000 .751 30,040 73,000
    4 50,000 .683 34,150 1,07,150
    5 30,000 .620 18,600 1,25,750

    Completed years + Required inflow *12


    PBP = Inflow of Next year
    = 3years+ (1,00,000-73,000)*12
    34150
    = 12.48 years

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