Capital Budgeting

Decision Criteria
The Investment Decision
 Financial Decisions.

 Investment decisions
 Financing decisions
 Liquidity decisions
 Dividend decisions
Investment Decisions
Basic Terminology

Capital Investment
Capital Project
Capital Budgeting
 Capital Investment

 Investmentin Real Assets

such as Land, Plant &
Machinery, Building and
Financial Assets such as
Shares, Bonds etc.
 Capital Projects

A set of asset investments

that are contingent on one
another and are considered
together.
 Capital Budgeting

 The process of identifying

and selecting investment in
assets whose expected
benefits exceed their costs.
 Classifying Projects
 Short-term Vs. Long term
projects(Time)
 Replacement Vs. Expansion
projects( Nature of project)
 Independent Vs. Mutually Exclusive
projects ( Degree of dependence)
 Contingent Projects (Degree of
dependence)
 Short/Long-term Projects

 Short-term: If benefits are received

within current period.
 Long-term: If benefits are received
beyond the asset period( capital
expenditure).
 Replacement/Expansion

 Replacement:
Maintain current level of operating
activity.
 Expansion:

Broaden existing product lines.

 Independent/Mutually Exclusive

 Independent:
Acceptance /Rejection is independent
 Mutually Exclusive:

Acceptance of one project leads to

rejection of another
 Contingent Projects

 Projects that are dependent on another

project’s acceptance/rejection.
 Capital Budgeting
&
Shareholder Wealth Maximization

 You are the CFO of 20th Century Old

Fox. Your company is planning to
make a big budget movie called Desi
Jurassic Park. List the information you
need to make a decision.
 CFO Speak
 Suppose you estimated that the movie making
would cost 500mn and you expect yearly cash
flows(mn) as below in how many years would
you recover your investment?
(500) 150 150 100 100 150 150 150 150

0 1 2 3 4 5 6 7 8
 CFO Speak
 Suppose a project costs Rs.2,50,000 and you
expect cash flows as below and the opportunity
cost to your shareholders is 10% do you think
accepting this project would increase their
wealth? Use the template in the next slide to
help you in your decision making:
70,000 70,000 70,000 70,000 70,000
(2,50,000)

0 1 2 3 4 5
 CFO Help Desk

Year Cash flows PVIF@ ?% PV

( in Rs.000’s) ( in Rs.000’s)
0 (2,50,000) 1.00 (2,50,000)
1 70,000
2 70,000
3 70,000
4 70,000
5 70,000
Total PV of Cash
inflows
Answer?????? ?
 CFO Speak
 Suppose a project costs Rs.2,50,000 and you
expect cash flows as below and you have been
asked to find the discount rate at which the
sum total of the expected cash flows will equal
the initial outflow of Rs.2,50,000 what is your
answer?
70,000 70,000 70,000 70,000 70,000
(2,50,000)

0 1 2 3 4 5