Methods of capital budgeting

Methods of capital budgeting- 1. ARR method
2. Payback method and example

1. By Asimananda mahato Methods OF Capital Budgeting

2. Capital Budgeting Capital budgeting is the planning process used to determine a firms long term investments . Such as new machinery , replacement machinery, new products etc. The term capital budgeting is otherwise called as investment appraisal .

3. Capital Budgeting Process Planning Analysis : a. Market analysis b . Technical analysis c. Financial analysis d. Economic analysis Selection Implementation Review

4. Objectives Of Capital Budgeting To find out the profitable capital expenditure. To decide whether a specified project is to be selected or not. To evaluate the merits of each proposal to decide which project is best. To assess the various sources of finance for capital expenditure.

5. Methods Of Capital Budgeting Net present value Internal rate of return Accounting rate of return Payback period Profitability index

6. Accounting 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 on Average investment = Average Profit After Tax * 100 Average investment ARR on Initial investment = Average Profit After Tax *100 Initial investment

7. Pay Back Period In discounted pay- back period method, the cash inflows are discounted by applying the present value factors for different time periods. For this, discounted cash inflows are calculated by multiplying the P.V. factors into cash inflows . Dis. PBP = Completed years + Required inflow *12 In flow of next year

8. Example The cost of plant is Rs.500000.It has been estimated life of 5 years after which it would be deposited off(scrap value nil).Profit before depreciation, interest & taxes(PBIT) is estimated to be Rs . 175000 p.a . Find out the yearly cash flow from the plant . Tax rate 30%.