Unit 02 : Capital Budgeting
ihcsi
it ling
investment decisions icernÉ with
are the selection of assets in which
funds will be invested by thefirm
investment in long term assets or capital expenditure
investment
offunds has to be made through carefulassessment of th
variousprojects
L
CapitalBudgeting capital Budgeting refers to the processofmaking
decisions
regarding capital investments infixedassets
It involves identifying analyzing and selecting thelongterm investmentprojects
whose returns cashflows are expected to extend beyond one
year
Features
longTerm investment thesedecisions generally involve investments
for a
longtime i.e severalyears The return comes over an extendedperiod
which requires the decision maker to make a calculated committement into
thefuture Thus it involves the exchange of currentfunds forfuture
benefits
Large Anticipated Cost capital budgeting involves huge amount ofmoney
which is to be invested into longterm or finedassets
HighDegreeofRisk since it involves
longperiods large amounts there
a lot of uncertainty
Situations where CapitalBudgeting decisions are needed
, Expansion companywishesto itscapacity expandoperations
increase
Modernisation upgradeold
machinerytonewer
efficienttechnology
anothercompanytoincreasemarketshare
Acquisition buy
Replacement replacingold
assetswithnewones
Importance
ofCapitalsums
Budgeting
investments big ofmoney longtimeperiod
large
MoreRisky futureis
uncertain
invested moneycannotbeeasilytakenback
Irreversability once
Effect eitheri ncreaseprofitsorcausehugelosses
on profitability
forecastingrequires
a nalysis
of investment decisions
Difficulties
National Importance growthof e conomy employment
Typesof Capital Budgeting Decisions
AcceptRejectDecisions option
Multipleoptions
Mutually Exclusive Decisions
CapitalRationing Decisions multipleoptions properallocation offunds
Process
of
Capital Budgeting
1 Identification investmentproposals
of involves identifyingpotential investment
opportunities generally done bytoplevel capitalexpenditureplanning committee
2 Screening theproposals involves a feasibilitystudy to check
iftheoptionsfitthe
company's goals andstrategies
3 Evaluation
ofproposals analysingeachprojectusingtheevaluation techniques and
estimating the cashflows tocheck profitability
4 Selectingthe bestproposal chosetheproposal whichgivesthe bestreturn withthe
least risk
5 implementation findapprovalandpreparation ofcapital expenditure budget before
Techniques
ofCapital Budgeting
traditional modern
PBP ARR NPV IRR PI
, implementingtheproposal
6 Performance Review afterthe investment is made check regularly if it isgivingthe
expected results or not
TimeValueofMoney
The value of money varies overtime The valueof money receivedtoday is
more than the value of the same amount
of money received after a certain
period This is called as time preference ofmoney
Certainreasons
forthisphenomenon are
future is uncertain involves risk
present needs are consideredurgent as compared tofuture needs
opportunities to invest moneyearlier orenhancefuture earnings
Techniques
oftimevalueofmoney
Compounding technique
Discounting technique
Compounding Technique
Compounding techniques are used to convert present values to future values
MultipleCompounding Periods
mm Single amount EV Pv Iti
EV
pulity
where m FV Ax t
jffl ncyof
compounding
Evenseries deferredannuity end
1 itr
annuitydue beginning
FV Ax 1
c.tt
Effitiipierst
utnaiings
m
EIR UnevenSeries FV Pv Citi t pvzcitign.at
i im 1
V PV Act or Practiciti
DoublingPeriod ruled 2 I ital
Ruleof69 DP 0.35 69rateofint
, Discounting Technique
Discountingtechniques are used to convertfuturevalues intopresentvaluecashflows
Discountingfactor titi
PV
Single amount
F1 n
unit Pr Fv cation
Evenseries deferredannuity end
Pr
annuitydue beginning Fulcifying
unevenseries or
It Eat Eight Yin
5000today at 6
Ifyoudeposit ofinterest in howmanyyearswillthisamount
double WorkoutusingRuleof72andRuleof69
A 5,000 r 6
7
using Ruleof72 12years
Using Ruleof69 69 0.35 11.85years
calculatethe compound value
of 10,000at the end
of 3years at 12 rateofinterest
wheninterest is calculated on a a yearly basis
b a quarterly basis
3 i 12
a Ev suite
10,000 1 0.12 3
i FV 14049.28
4
041213
b FV 10,000 1
ihcsi
it ling
investment decisions icernÉ with
are the selection of assets in which
funds will be invested by thefirm
investment in long term assets or capital expenditure
investment
offunds has to be made through carefulassessment of th
variousprojects
L
CapitalBudgeting capital Budgeting refers to the processofmaking
decisions
regarding capital investments infixedassets
It involves identifying analyzing and selecting thelongterm investmentprojects
whose returns cashflows are expected to extend beyond one
year
Features
longTerm investment thesedecisions generally involve investments
for a
longtime i.e severalyears The return comes over an extendedperiod
which requires the decision maker to make a calculated committement into
thefuture Thus it involves the exchange of currentfunds forfuture
benefits
Large Anticipated Cost capital budgeting involves huge amount ofmoney
which is to be invested into longterm or finedassets
HighDegreeofRisk since it involves
longperiods large amounts there
a lot of uncertainty
Situations where CapitalBudgeting decisions are needed
, Expansion companywishesto itscapacity expandoperations
increase
Modernisation upgradeold
machinerytonewer
efficienttechnology
anothercompanytoincreasemarketshare
Acquisition buy
Replacement replacingold
assetswithnewones
Importance
ofCapitalsums
Budgeting
investments big ofmoney longtimeperiod
large
MoreRisky futureis
uncertain
invested moneycannotbeeasilytakenback
Irreversability once
Effect eitheri ncreaseprofitsorcausehugelosses
on profitability
forecastingrequires
a nalysis
of investment decisions
Difficulties
National Importance growthof e conomy employment
Typesof Capital Budgeting Decisions
AcceptRejectDecisions option
Multipleoptions
Mutually Exclusive Decisions
CapitalRationing Decisions multipleoptions properallocation offunds
Process
of
Capital Budgeting
1 Identification investmentproposals
of involves identifyingpotential investment
opportunities generally done bytoplevel capitalexpenditureplanning committee
2 Screening theproposals involves a feasibilitystudy to check
iftheoptionsfitthe
company's goals andstrategies
3 Evaluation
ofproposals analysingeachprojectusingtheevaluation techniques and
estimating the cashflows tocheck profitability
4 Selectingthe bestproposal chosetheproposal whichgivesthe bestreturn withthe
least risk
5 implementation findapprovalandpreparation ofcapital expenditure budget before
Techniques
ofCapital Budgeting
traditional modern
PBP ARR NPV IRR PI
, implementingtheproposal
6 Performance Review afterthe investment is made check regularly if it isgivingthe
expected results or not
TimeValueofMoney
The value of money varies overtime The valueof money receivedtoday is
more than the value of the same amount
of money received after a certain
period This is called as time preference ofmoney
Certainreasons
forthisphenomenon are
future is uncertain involves risk
present needs are consideredurgent as compared tofuture needs
opportunities to invest moneyearlier orenhancefuture earnings
Techniques
oftimevalueofmoney
Compounding technique
Discounting technique
Compounding Technique
Compounding techniques are used to convert present values to future values
MultipleCompounding Periods
mm Single amount EV Pv Iti
EV
pulity
where m FV Ax t
jffl ncyof
compounding
Evenseries deferredannuity end
1 itr
annuitydue beginning
FV Ax 1
c.tt
Effitiipierst
utnaiings
m
EIR UnevenSeries FV Pv Citi t pvzcitign.at
i im 1
V PV Act or Practiciti
DoublingPeriod ruled 2 I ital
Ruleof69 DP 0.35 69rateofint
, Discounting Technique
Discountingtechniques are used to convertfuturevalues intopresentvaluecashflows
Discountingfactor titi
PV
Single amount
F1 n
unit Pr Fv cation
Evenseries deferredannuity end
Pr
annuitydue beginning Fulcifying
unevenseries or
It Eat Eight Yin
5000today at 6
Ifyoudeposit ofinterest in howmanyyearswillthisamount
double WorkoutusingRuleof72andRuleof69
A 5,000 r 6
7
using Ruleof72 12years
Using Ruleof69 69 0.35 11.85years
calculatethe compound value
of 10,000at the end
of 3years at 12 rateofinterest
wheninterest is calculated on a a yearly basis
b a quarterly basis
3 i 12
a Ev suite
10,000 1 0.12 3
i FV 14049.28
4
041213
b FV 10,000 1
