capital budgetingby,s.k.gupta

8/9/2019 Capital BudgetingBy,S.K.guptA

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CAPITAL BUDGETING

By, S.K.GuptaHEAD, DEPT. OF COMMERCE

S.D.JAIN GIRLS COLLEGE

DIMAPUR: NAGALAND


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CAPITAL BUDGETING

Capital budgeting is a decision situation where large fundsare committed (invested) in the initial stages of the projectand the returns are expected over a long period of time.

These decisions are related to allocation of investible fundsto different long-term assets.

Capital budgeting is a continuous process and it is carriedout by different functional areas of management such as

production, marketing, engineering, financial managementetc.


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BASIC FEATURES OF CAPITALBUDGETING

Capital budgeting decisions have long-termimplications.

These decisions involve substantial commitment of funds.

These decisions are irreversible and require analysisof minute details.

These decisions determine and affect the futuregrowth of the firm.


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CAPITAL BUDGETING PROCESS :

Capital budgeting is a difficult process to theinvestment of available funds. The benefit

will attained only in the near future but, thefuture is uncertain. However, the following

steps followed for capital budgeting, then the process may be easier are.


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Capital-Budgeting Process


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KINDS OF CAPITAL BUDGETINGDECISIONS

The overall objective of capital budgeting is tomaximize the profitability. If a firm

concentrates return on investment, thisobjective can be achieved either by increasingthe revenues or reducing the costs. Theincreasing revenues can be achieved byexpansion or the size of operations by adding anew product line. Reducing costs meanrepresenting obsolete return on assets.


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DECISION CRITERIA TECHNIQUES OFEVALUATION

Traditional or Time-adjusted or Non-discounting Discounted cash flows

1. Payback period 1. Net Present Value2. Accounting Rate of 2. Profitability Index

Return 3 . Internal Rate of Return


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TRADITIONAL OR NON-DISCOUNTINGTECHNIQUES

I . PAYBACK PERIOD:

# The payback period is defined as the number of years required for the proposals cumulative cash inflows to beequal to its cash outflows.

# The payback period is the length of time required

to recover the initial cost of the project.# The payback period may be suitable if the firm

has limited funds available and has no ability or willingness toraise additional funds.


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II . ACCOUNTING RATE OF RETURN (OR) AVERAGE RATE OF RETURN (ARR)

# The ARR may be defined as the annuali zed netincome earned on the average funds invested in a project.

# The annual returns of a project are expressed as a

percentage of the net investment in the project.

COMPUTATION OF ARR:

Average Annual profit (after tax)

ARR = x 100

Average Investment in the Project


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DISCOUNTED CASH FLOWS OR TIMEADJUSTED TECHNIQUES

These are based upon the fact that the cash flows occurring atdifferent point of time are not having same economic worth.

I. NET PRESENT VALUE (NPV) METHOD :

The NPV of an investment proposal may be defined as the sumof the present values of all the cash inflows less the sum of present

values of all the cash outflows associated with the proposal.The decision rule is Accept the proposal if its NPV is positive

and reject the proposal if the NPV is negative.


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II . PROFITABILITY INDEX METHOD :

This technique is a variant of the NPV technique and is also

known as BENEFIT - COST RATIO or PRESENT VALUE INDEX .

Total present value of cash inflows

PI =

Total present value of cash outflows.

Accept the project if its PI is more than 1 and rejectthe proposal if the PI is less than 1.


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III. INTERNAL RATE OF RETURN (IRR) METHOD :

The IRR of a proposal is defined as the discount rate which produces a zero NPV, i.e., the IRR is the discount rate which willequate the present value of cash inflows with the present value of cash outflows.

The IRR is also known as Marginal Rate of Return or Time Adjusted Rate of Return .

The time-schedule of occurrence of future cash flows isknown but the rate of discount is not.

The discount rate calculated will equate the present value of cash inflows with the present value of cash outflows.

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THANKS YOU

capital budgetingby,s.k.gupta

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