Detailed_Capital_Budgeting_Presentation.pptx

Detailed_Capital_Budgeting_Presentation

1. Capital Budgeting: Investment Decisions Presented by: Deepak N C Koshys Institute of Management Studies

2. Introduction to Capital Budgeting • Process of investing in long-term assets for future benefits. • Key Features: - Exchange of current funds for future benefits. - Funds invested in long-term assets. - Benefits occur over multiple years.

3. Capital Expenditures & Their Importance • Capital expenditure involves a current outlay for future benefits. • Importance: - Long-term impact on business. - Requires substantial funds. - Difficult to reverse once made.

4. Capital Budgeting Process 1. Identification of Investment Opportunities 2. Assembling Investment Proposals 3. Decision Making 4. Capital Budget Preparation 5. Implementation 6. Performance Review

5. Key Aspects of Capital Budgeting • Go or No-Go Decision on investment proposals. • Requires accurate estimation of cash flows. • Uses predefined accept/reject criteria.

6. Payback Period Method • Time required to recover the initial investment. • Decision Rule: Shorter payback period preferred. • Merits: - Simple and easy to calculate. - Useful for liquidity management. • Limitations: - Ignores time value of money. - Excludes cash flows beyond payback period.

7. Accounting Rate of Return (ARR) • Measures average annual net income as a percentage of investment. • Decision Rule: Higher ARR preferred. • Limitation: Uses accounting profits, not cash flows.

8. Net Present Value (NPV) • Considers time value of money. • Formula: NPV = PV of Net Cash Inflows - Initial Investment. • Advantages: - Reflects time value of money. - Considers all cash flows. • Disadvantages: - Absolute measure, not relative. - Favors longer-term projects.

9. Profitability Index (PI) • Also called Present Value Index. • Formula: PI = PV of Cash Inflows / Initial Investment. • Helps in ranking projects based on value creation.

10. Internal Rate of Return (IRR) • Discount rate at which NPV = 0. • Used to evaluate project profitability. • Higher IRR preferred, but can lead to ranking errors in some cases.

11. Comparison of Capital Budgeting Methods • Payback Period: Simple but ignores time value of money. • NPV: Best method, considers time value and all cash flows. • IRR: Popular but can give misleading rankings. • PI: Useful for comparing different investment sizes.

12. Discussion Questions 1. How do businesses evaluate capital investment decisions? 2. What are the key differences between short-term and long-term decisions? 3. Why is NPV considered superior to the payback period method? 4. What are the limitations of IRR? 5. When should companies use the Profitability Index?