Unit 4-Capital Budgeting

Sri Krishna College of Technology
School of Management
CAPITAL
BUDGETING
Unit 4

Name of the Faculty: KARTHIKEYAN N
Subject Code & Title:18PNC209 & FINANCIAL

MANAGEMENT
Academic Year: 2018-2019
Class & Trimester: I year – 02 Trimester
Regulations: 2018
Karthikeyan N-Asst. Prof./ Som-SKCT

3

4
Session No.- 1
• Topics to be covered:
• Capital Budgeting: Nature and Principles
• Learning Objectives
- Capital Budgeting meaning
- OBE- Remember and Understand

5
Capital Budgeting- Meaning
Planning the For the purpose of

maximising the long
allocation of term profitability of the
available capital firm

6
Capital Budgeting- Definition

• “The firm’s decision to invest its current funds more
efficiently in the long term assets in anticipation of an
expected flow of benefits over a series of time”
• “ The firm’s formal process for the acquisition and

investment of capital”

7
Capital Budgeting
Returns
Identify are
Projects/ expecte
Analyse d to
Capital
Investment flow Budgeting
avenues over
years

8
Returns should Capital

Capital flow over years Expenditure
• Buy/Invest
• Expenditure/Outlay Funds Requires
for allocation

9
Features of Capital Budgeting

• Exchange of current funds for future benefits.
• Benefits will result for future periods.
• Funds are invested in long-term activities (Purchase of

FA, Expansion of business)

10
Significance (or) Importance of Capital Budgeting
• Growth
• More Risky
• Huge Investments
• Irreversibility
• Effect on other projects
• Long term consequences
• Strategic Allocation may be made

11
Capital Budgeting Process/Steps

Project Generation
Screening the available resources
Project Evaluation
Project Selection
Project Execution
Project Review

12
Capital Budgeting -Principles
• Creative search for profitable opportunities

• Long range capital planning
• Short range capital planning
• Measurement of project work
• Screening and Selection
• Retirement and Disposal
• Forms and Procedures

13
Classification of investment proposals/ Project Classification
• Mandatory Investments.
• Replacement Projects.
• Expansion Projects.
• Diversification Projects.
• Research and Development Projects

14
Points to Ponder
• Planning the allocation of available capital
• For the purpose of maximising the long term profitability of the
firm
• The firm’s formal process for the acquisition and investment of
capital
• Exchange of current funds for future benefits

15
Key words
• Planning
• Allocation
• Long term profitability
• Exchange
• future benefits

16
Learning Outcomes
• At the end of the course, a student will able
• To remember capital budgeting concepts
• To understand the need of capital budgeting

17
Topics to be covered in the next session

• Cash Flows- DCF Techniques
• Net Present Value
• Internal Rate of Return
• Profitability Index

18
Session No.- 2
• Cash Flows- DCF Techniques
• Profitability Index

19
- Capital Budgeting DCF Techniques
- Which project should be accepted and rejected
based on techniques

20
OBE- Understand, Apply and Analyse

21
Capital Budgeting
Techniques
Traditional Modern Technique or

Technique or Non Discounting Technique
Discounting
Technique
Net Internal
Profitabil
Present Rate of
ity Index
Pay Accounting Rate of Value Return
Back Return or Average
Period Rate of Return

22
Net Present Value
• This method tells the real or actual value of an

investment as it takes time value into consideration.
• NPV= PV of CI – PV of CO
• Positive NPV – PV of CI > PV of CO
Negative NPV – PV of CI < PV of CO
• Accept / Reject Rule
Positive NPV = Accept
Negative NPV = Reject
(Usually higher NPV must be selected incase of positive NPV’s for two or more
proposals)

23
Profitability Index Method/ Benefit Cost Ratio
Method/Discounted Benefit Cost Ratio
• This method is used to Rank the projects.
• PI=PV of CI/ PV of CO
• Accept/ Reject Rule:

PI>1 = Accept
PI<1 = Reject

24
Internal Rate of Return

• This method is used to find out the maximum ROI at
which funds are invested in a project
• IRR is the rate at which PV of CI = PV of CO ie. NPV will
be zero
𝐿𝐷𝑃𝑉−𝑂𝐼
• 𝐿𝐷𝐹% + [∆𝐷𝐹 ]
𝐿𝐷𝑃𝑉−𝐻𝐷𝑃𝑉
• Accept/ Reject Rule:

IRR>Cost of Capital = Accept
IRR<Cost of Capital = Reject

25
Points to Ponder
• Net Present Value- This method tells the real or actual value of
an investment as it takes time value into consideration
• NPV= PV of CI – PV of CO
• Profitability Index Method- This method is used to Rank the
projects
• PI=PV of CI/ PV of CO
• Internal Rate of Return-This method is used to find out the
maximum ROI at which funds are invested in a project
• IRR- PV of CI = PV of CO

26
Key words
• Real or actual value
• Profitability Index Method
• Rank the projects
• maximum ROI

27
Learning Outcomes
• To understand the DCF techniques
• To apply the DCF techniques to evaluate the
proposals
• To analyse which proposals to be selected and
rejected

28

• Non Discounted Cash Flow Techniques
Pay Back and Accounting Rate of Return

29 Sri Krishna College of Technology
Session No.- 3
• Cash Flows- Non-DCF Techniques
• Pay back Period
• Accounting/Average rate of Return

- Capital Budgeting techniques.
- Which project should be accepted and rejected based
on Non-DCF techniques

- OBE- Understand, Apply and Analyse

32
Pay Back Period
• Number of years required to recover the initial cash

outlay invested in a project
Initial Investment (or) Cash outflow
Annual Cash Inflow
• Accept/Reject Rule:
Shorter PBP – ACCEPT
Longer PBP - REJECT

33
Accounting/ Average Rate of Return
• Returns that are expected from the projects invested.

(Profits received from the project)
• Accounting RoR = PADAT or Average Annual Profit

Original Investment
• Average RoR= PADAT or Average Annual Profit
Average Investment
• Higher RoR- Accept
Lower RoR- Reject

34
Difference between NPV and IRR

NPV IRR
Interest rate is known Interest rate is not known
This involved in computation of amount This attempts to find out the maximum
that can be invested in a given project so rate of interest at which funds are
that the anticipated earnings will be invested in the project. Earnings from the
sufficient to repay this amount with market projects in the form of cash flow will help
us to get back the funds already invested
It assumes that the cash inflows can be It also assumes that the cash inflows can
reinvested at the discounting rate in the be re invested at the discounting rate in
new projects the new projects
Re investment is assumed to be at the Reinvestment in funds is assumed to be
cut-off rate at the IRR
NPV= PV of CI – PV of CO 𝐿𝐷𝑃𝑉 − 𝑂𝐼
𝐿𝐷𝐹% + [∆𝐷𝐹 ]
𝐿𝐷𝑃𝑉 − 𝐻𝐷𝑃𝑉

35
Points to Ponder
• Pay Back Period- Number of years required to recover the initial
cash outlay invested in a project
• Accounting/ Average Rate of Return- Returns that are expected
from the projects invested

36
Key words
• Pay Back Period-
• Number of years required
• Accounting/ Average Rate of Return
• Returns

37
Learning Outcomes
• To understand the Non-DCF techniques
• To apply the Non-DCF techniques to evaluate the
proposals
• To analyse which proposals to be selected and
rejected

38

• Unit 5- Dividend

Unit 4-Capital Budgeting

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Unit 4-Capital Budgeting

Uploaded by

Copyright:

Available Formats

Sri Krishna College of Technology

Sri Krishna College of Technology

Name of the Faculty: KARTHIKEYAN N

Subject Code & Title:18PNC209 & FINANCIAL

Academic Year: 2018-2019

Class & Trimester: I year – 02 Trimester

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

- OBE- Remember and Understand

Karthikeyan N-Asst. Prof./ Som-SKCT

Capital Budgeting- Meaning

Planning the For the purpose of

Karthikeyan N-Asst. Prof./ Som-SKCT

Capital Budgeting- Definition

• “ The firm’s formal process for the acquisition and

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Returns should Capital

Karthikeyan N-Asst. Prof./ Som-SKCT

Features of Capital Budgeting

• Benefits will result for future periods.

• Funds are invested in long-term activities (Purchase of

Karthikeyan N-Asst. Prof./ Som-SKCT

Significance (or) Importance of Capital Budgeting

Karthikeyan N-Asst. Prof./ Som-SKCT

Capital Budgeting Process/Steps

Karthikeyan N-Asst. Prof./ Som-SKCT

Capital Budgeting -Principles

• Creative search for profitable opportunities

Karthikeyan N-Asst. Prof./ Som-SKCT

Classification of investment proposals/ Project Classification

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Topics to be covered in the next session

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

OBE- Understand, Apply and Analyse

Karthikeyan N-Asst. Prof./ Som-SKCT

Traditional Modern Technique or

Karthikeyan N-Asst. Prof./ Som-SKCT

Net Present Value

• This method tells the real or actual value of an

Karthikeyan N-Asst. Prof./ Som-SKCT

• This method is used to Rank the projects.

• Accept/ Reject Rule:

Karthikeyan N-Asst. Prof./ Som-SKCT

Internal Rate of Return

• Accept/ Reject Rule:

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Topics to be covered in the next session

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

Karthikeyan N-Asst. Prof./ Som-SKCT

- OBE- Understand, Apply and Analyse

Karthikeyan N-Asst. Prof./ Som-SKCT

Pay Back Period

• Number of years required to recover the initial cash