Capital Budgeting.pptx business capital budgeting

Capital budgeting

1. Capital Budgeting and It’s Need , Importance and Techniques

2. Definition Also known as an investment decision Capital Budgeting is a process in which company decides about the investment that it has to make in the future It involves the planning of expenditures on assets whose cash flows are expected to extend beyond one year.

3. Process of Capital Budgeting 1:Project Identification: Company identifies the project where he can invest the capital. 2:Project Evaluation: After identification , company evaluates that which type of project generates high return. 3:Project Selection: Company selects the project which provides high return 4:Project Execution: After selection company invests the capital in that particular project which is selected by company.

4. Decisions of Capital Budgeting: 1:Accept/Reject Decisions: Accept if expected rate of return is greater than cost of capital.Rejected if expected rate of return is low than cost of capital. 2:Mutually Exclusive Decisions : companies choose a single project on the basis of certain parameters out of the set of the projects where acceptance of one project will lead to rejection of the other projects . 3:Capital Rationing Decisions : Capital rationing is a process that companies use to decide which investment opportunities make the most sense for them to pursue.

5. Need for Capital Budgeting 1. Long-term Investment Decisions • Purpose : Helps in evaluating and selecting long-term projects. • Impact: Influences the future growth and sustainability of the business. 2. Efficient Resource Allocation • Purpose: Ensures optimal use of limited financial resources. • Impact: Directs funds to the most profitable and strategic projects. 3. Risk Management • Purpose: Identifies and assesses potential risks associated with investments .• Impact: Helps in mitigating financial risks and making safer investment choices. 4. Financial Planning and Performance • Purpose: Assists in forecasting future cash flows and returns. • Impact: Aids in budgeting, financial planning, and measuring financial performance.

6. 5. Capital Cost Control • Purpose: Monitors and controls the costs associated with large projects. • Impact: Prevents cost overruns and ensures projects are completed within budget. 6. Shareholder Value Maximization • Purpose : Focuses on investments that increase the value of the firm. • Impact: Enhances shareholder wealth and company valuation.

7. Importance of Capital Budgeting 1:Cost Control: It helps in keeping track of the costs associated with large projects and ensures that they do not exceed the budget. 2: Optimizing Returns: By choosing projects with the highest potential returns, businesses can optimize their overall financial performance. 3: Improving Efficiency: Capital budgeting promotes efficient use of capital, ensuring that funds are directed toward the most productive uses.

8. 4. Supporting Growth: It is essential for the sustainable growth of a company by enabling investments in new products, technologies, and markets. 5 . Regulatory Compliance: For certain industries, capital budgeting is necessary to meet regulatory requirements and ensure legal compliance.

9. Techniques of Capital Budgeting 1. Net Present Value (NPV): Difference between the present value of cash inflows and outflows.A positive NPV indicates a profitable investment. NPV = FV / [ (1 + i)^n ] 2. Internal Rate of Return (IRR): The discount rate that makes the NPV of an investment zero. IRR=r(Discount Rate) 3.Payback Period: The time required for an investment to generate cash flows sufficient to recover the initial cost. PB=T(time taken for initial investment to be recovered)

10. 4. Profitability Index (PI): Ratio of the present value of cash inflows to the initial investment.A PI greater than 1 indicates a good investment. PI=PV of future cashflows / Initial investment 5. Accounting Rate of Return (ARR): Return on investment based on accounting information rather than cash flows. ARR=Average Annual Profit / Initial investment # Average Annual Profit = Total Profit / Number of years

11. Summary 1. Capital budgeting is essential for making informed investment decisions that align with strategic goals. 2.It involves evaluating potential investments based on their expected cash flows and profitability. 3.Various techniques such as NPV, IRR, Payback Period, PI, and ARR provide different perspectives on the viability of investments. 4.Effective capital budgeting ensures long-term financial stability and growth.