Capital budgeting ppt

helpful for finance student(BBA, MBA)

1. Capital Budgeting
An Investment Decision Method
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Presented by
Ruchi Jain

2. 1.
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3.
4.
5.
6.
7.
8.
Definition of Budget
Budget Sector and Types of Budget
Capital Budgeting
Importance of Capital Budgeting
Capital Budgeting : Project Categorization
Capital Budgeting: Eight Steps
EvaluationCriteria:CapitalInvestmentAppraisals
Conclusions
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3. DefinitionofBudget
•Budgetingisamanagementtoolforplanningand
controllingfutureactivity.
FinancialBuzzWords:Aplanforsaving,borrowingandspending.
•Budgetisafinancialplanandalistofallplanned
expensesandrevenues.
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4. BudgetSector BudgetTypes
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BasisofFlexibility:FixedandVariableBudget
BasisofTimePeriod:Short-Termand
Long–TermBudget
BasisofFunctionality:Salesbudget,
Productionbudget,Marketingbudget,Project
budget,Revenuebudget,Cashflow/cash
budgetetc.
Buisness
start-up
budget
Corporate/
Buisness
budget
Government
budget
Event
management
budget
Personal /
Family budget
Govt. Budget in India Prepared by:
Budget division of Economics Department of Ministry of Finance

5. Capital Budgeting
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Capital:Operatingassetsusedforproduction.
Budget:Aplanthatdetailsprojectedcashflowsduringsomeperiod.
CapitalBudgeting:Processofanalyzingprojectsanddecidingwhich
onestoincludeincapitalbudget.

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Importance of Capital Budgeting
BenefitsofCapitalBudgetingDecision:
CapitalBudgetingdecisionsevaluateaproposedprojecttoforecast
returnfromtheprojectanddeterminewhetherreturnfromtheProjectis
adequate.
CapitalBudgetingdecisionsevaluateexpendituredecisionswhich
involvecurrentoutflowoffundsbutarelikelytoproducebenefitsovera
periodoftimemorethanoneyear.
Growth
Large Amount
Irreversibility
Complexity
Risk
Long term implications

7. Capital Budgeting: Project Categorization
•Establishment of New Products & Services
•Replacement Projects: Maintenance or Cost Reduction
•Expansion of Existing Projects
•Research and Development Projects
•Long Term Cotracts
•Safety and/or Environmental Projects
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8. CapitalBudgetingistheplanningprocessusedtodetermineafirm’s
longterminvestmentssuchasnewmachinery,replacementmachinery,
newplants,newproductsandresearch&developmentprojects.
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BroadProspective

9. Evaluation Criteria: Capital Investment Proposal
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Evaluation Criteria
Non-Discounting
Criteria
Pay-Back
Period
ARR
Discounting
criteria
NPV
Discounted
PBP
Profitability
Index
IRR
FourthImportantStepofcapitalbudgeting:
carryoutFinancialAnalysis

10. Non discounting: Pay-Back Period
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1.Pay-BackPeriodMethod-Itisdefinedasthe
numberofyearsrequiredtorecoveroriginalcost
investedinaproject.Ithastwoconditions
Whencashinflowisconstanteveryyear
PBP=Cashoutflow/cashinflow(p.a.)
Whencashinflowarenotconstanteveryyear
PBP=
Completedyears+ *
12
Requiredinflow
Inflowofnextyear

11. Non discounting Criteria: Annual Rate of Return
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2.AverageRateofReturnMethod-ARRmeansthe
averageannualearningontheproject.Underthismethod,
profitaftertaxanddepreciationisconsidered.Theaverage
rateofreturncanbecalculatedinthefollowingtwoways.
ARRonAverageinvestment=
ARRonInitialinvestment =
*
100
AverageProfitAfterTax
AverageInvestment
*100
AverageProfitAfterTax
InitialInvestment

12. Discounting Criteria: Pay-Back Period
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3.DiscountedPay-BackPeriodMethod-Indiscounted
pay-backperiodmethod,thecashinflowsarediscounted
byapplyingthepresentvaluefactorsfordifferenttime
periods.Forthis,discountedcashinflowsarecalculated
bymultiplyingtheP.V.factorsintocashinflows.
Completedyears+
*
12
Requiredinflow
Inflowofnextyear
Dis.PBP=

13. Discounting Criteria: Net Present Value
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4.NetPresentValueMethod:-Itisthebestmethodfor
evaluationofinvestmentproposal.Thismethodtakesinto
accounttimevalueofmoney.
NPV=PVofinflows-PVofoutflows
EvaluationofNetPresentValueMethod:-Project
withthehigherNPVshouldbeselected.
Acceptif NPV>0
Reject NPV<0
Mayormaynotaccept NPV=0

14. Discounting Criteria: Profitability Index
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5.ProfitabilityIndexMethod-AstheNPVmethoditis
alsoshowsthatprojectisacceptedornot.IfProfitability
indexishigherthan1,theproposalcanbeaccepted.
Accepted PI>1
Rejected PI<1
Profitabilityindex=
TotalCashInflows
TotalCashOutflows

15. Discounting Criteria: Internal Rate of Return
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5.InternalRateofReturnMethod:-IRRistherateof
returnthataprojectearns.Therateofdiscountcalculatedby
trialanderror,wherethepresentvalueoffuturecashflowsis
equaltothepresentvalueofoutflows,isknownastheInternal
RateofReturn.
*DifferenceinRate
NPVofHigherRate
Differenceincashflows
IRR=HigherRate
+ *DifferenceinRate
NPVofLowerRate
Differenceincashflows
IRR=LowerRate
-

16. The expected cash flows of a project are:-
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 periode) Discounted Pay-back Period
Year Cash Flows ( Rs.)
1 20,000
2 30,000
3 40,000
4 50,000
5 30,000
Example
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17. Computation of NPV & PI
YearCash Flows (Rs.)PVFactors@10%PV of Cash Flows (Rs.)
1 20,000 .909 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
Outflows
1,00,000
NPV 25,750
P.I. 1.2575
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Computation of NPV and PI

18. Computation of NPV & PI
YearCash
Flows (Rs.)
PVFactors
@19%
PV of Cash
Flows (Rs.)
PVFactors
@18%
PV of Cash
Flows (Rs.)
1 20,000 .84 16,800 .847 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 CashOutflows 1,00,000 1,00,000
NPV (-)750 (+)1750
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Computation of IRR

19. Computation of IRR Contd..
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20. Computation of non discounting pay-back period
YearCash 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
Completedyears+Requiredinflow*12
PBP= InflowofNextyear
=3years+(1,00,000-90,000)*12
50,000
=5.4years
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21. Computation of discounted pay-back period
YearCash Flows
(Rs.)
PV
Factors@10%
PV of Cash
Flows (Rs.)
Cumulative
Cash Flows
1 20,000 .909 18,18018,180
2 30,000 .826 24,78042,960
3 40,000 .751 30,04073,000
4 50,000 .683 34,1501,07,150
5 30,000 .620 18,6001,25,750
Completedyears+Requiredinflow*12
PBP= InflowofNextyear
=3years+(1,00,000-73,000)*12
34150
=12.48years
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22. Conclusions
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WehaveStudiedvariousevaluationcriteriaforCapital
Budgeting.
Generallyanimpressioncreatedthatthefirmshould
useNPVmethodfordecisionmaking.
Mostofthelargecompaniesconsiderallthemeasures
becauseeachoneprovidessomewhatdifferentpieceof
relevantinformationtothedecisionmaker.

23. THANK YOU!