CAPITAL EXPENDITURE

DECISIONS
 Learning objectives:

• To define capital budgeting

• To identify investment opportunities
• To provide reliable decisions in investment
opportunities
What is capital budgeting?
– it is a selection technique used to
evaluate long- term investment
proposals.

– the process of making long-term

planning decisions for alternative
investment opportunities.
What are the uses of capital
budgeting?
1. Cost reduction decisions
What are the uses of capital
budgeting?
2. Expansion decisions.
 What are the uses of capital
budgeting?
3. Equipment selection decisions.
4. Lease or buy decisions.
5. Equipment replacement
decisions.
 Capital budgeting answers the ff.
questions:
• should I replace certain equipment?

• should I expand facilities by renting additional

space, buying an existing building, or
constructing a new building?

• should I invest in high-tech information

technology (it)?

• should I launch new product development?

Capital budgeting answers the ff.
questions:
• do I have an opportunity to refinance an
outstanding debt issue? should I do it?

• I've been contemplating a merger. should I go

ahead with it?

• I've been thinking about adding a new product

to our line. should I?
 Features of Investment Projects
1. they typically involve a large amount of initial
cash outlays, which tend to have a long-term
impact on the firm’s future profitability.
Features of Investment Projects

2. there are expected recurring cash

inflows over the life of the investment
project.

3. income taxes could make a difference in

the accept or reject decision.
Techniques for Evaluating
Investment Proposal
• Payback Period
• Accounting Rate of Return
• Internal Rate of Return
• Net Present Value
• Profitability Index
Payback Period

– measures the length of time required to recover the

amount of initial investment.

FORMULA:
If Cash Inflow is even:
Payback Period = Initial Investment
Net Cash Inflows
Payback Period
Payback Period
Payback Period
What are the pros and cons of the
payback period method?

Pros Cons

it is simple it does not

to compute and recognize the time value of
money
easy to
understand
it ignores the
impact of cash inflows
it handles received after the payback
investment risk effectively period