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Capital Budgeting Techniques: The Islamia University of Bahawalpur Department of Finance-IBMAS
Capital Budgeting Techniques: The Islamia University of Bahawalpur Department of Finance-IBMAS
Capital Budgeting Techniques: The Islamia University of Bahawalpur Department of Finance-IBMAS
Capital Budgeting
Techniques
Dr. AMNA NOOR
The Islamia University of Bahawalpur
Department of Finance- IBMAS
–40 K 10 K 12 K 15 K 10 K 7K
10 K 22 K 37 K 47 K 54 K
Cumulative
Inflows
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Strengths: Weaknesses:
• Easy to use and • Does not account
understand. for time value of
• Can be used as a money.
measure of • Does not consider cash
liquidity. flows beyond the Pay
• Easier to forecast ST than back period.
LT flows. • Cutoff period is
subjective.
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Decision criteria:
– If the NPV is greater than $0, accept the project.
– If the NPV is less than $0, reject the project.
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Example:
Strengths: Weaknesses:
• Cash flows • May not include
assumed to be managerial
reinvested at the options embedded
hurdle rate. in the project.
• Accounts for time value
of money.
• Considers all
cash flows.
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Decision criteria:
– If the IRR is greater than the cost of capital, accept the project.
– If the IRR is less than the cost of capital, reject the project.
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Example:
• PV of cash flows = $ 59,612
• Initial cash flow = $ 52,125
• NPV = $ 7486
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Strengths: Weaknesses:
• Accounts for time • Assumes all cash
value of money. flows reinvested at
• Considers all the IRR.
cash flows. • Difficulties with
• Less subjectivity project rankings and
Multiple IRRs.
The Islamia University of Bahawalpur
Department of Finance- IBMAS
Capital Rationing
Capital Rationing occurs when a constraint (or
budget ceiling) is placed on the total size of
capital expenditures during a particular period.