PM Capital Budgeting 2
PM Capital Budgeting 2
PM Capital Budgeting 2
Namrata K
Introduction
Capital budgeting is the process of making
investment decisions in long term assets. It is the
process of deciding whether or not to invest in a
particular project as all the investment possibilities
may not be rewarding.
Irreversible
Decision
High Risk
Complex
Decision
Long term
impact on
Profitability
Features of Capital Budgeting
O Decision cannot be
R Undone
C
E Helps in Complex Investment
Decisions
Firm’s Decision
Situation
existence
1.Replaceme 1.Mutually
nt Exclusive
2.Modernizat 2.Accept /
ion Reject decision
3.Expansion 3. Contingent
4.Diversificat decisions
ion
Capital Budgeting Process
1. Identifying investment opportunities
YR 1=1-10/100=.909
YR 2=(1-10/100)^2=.826
YR 3= (1-10/100)^3=.755
FV 1= 100*.909=90.9
FV 2 = 100*.826=82.6
FV 3 = 100*.755=75.5
Non Discounting Methods
Solution:
Total Cash inflows 1,20,000 1,20,000
(in 3 Yrs)
Cash investment/ 3 yrs 2 yrs + 10,000/
annual cash inflow 40,000*12
2 yrs 3 months
1. It is very simple to
1. It uses accounting
understand and use. profits, not cash flows in
appraising the projects.
2. It can be readily 2. It ignores the time
calculated using the
value of money and cost
accounting data. of capital.
3. It uses the entire 3. It does not consider the
stream of incomes in lengths of projects lives,
calculating the profits occurring in
accounting rate. different periods are
valued equally.
4. It does not allow for the
fact that the profit can be
reinvested.
Example
Yr Profit after Tax and depreciation
0 - Rs.14(million)
1 Rs. 3
2 Rs. 4
3 Rs.5
4 Rs. 6
5 Rs. 10
Total Rs. 28
Average Return = 28/5=5.6
Average Investment=-14/2=-7
ARR= 5.6/7*100=80%
Initial Investment= $2,00,000
Cash inflow A Cum. Cash Cash inflow Cum. Cash
inflow B inflow
1 $ 70,000 $ 70,000 $ 45,000 $ 45,000
2 60,000 1,30,000 60,000 1,05,000
3 55,000 1,85,000 50,000 1,55,000
4 40,000 2,25,000 1,00,000 2,55,000
5 30,000 2,55,000 1,05,000 3,60,000
6 25,000 2,80,000 75,000 4,35,000
0 1 - 0-12,00,000 0
10,00,00
0
1 0.91741,00,000 917401,30,000 119262
2 0.84162,50,000 2104001,30,000 109408
3 0.77213,50,000 2702351,00,000 77210
4 0.70842,65,000 1877261,00,000 70840
5 0.64994,15,000 269708.51,70,000 110483
PV OF CASH 1029809.5 487203
INFLOWS
PV CASH
OUTFLOW 1000000 1200000
NPV 29809.5
Example
Yr PVF@18% Project PV of Project PV of
A cash B cash
0 1 -8320 -24,300
1 0.8475 3,411 5,000
2 0.7182 4070 5,000
3 0.6086 5824 5,000
4 0.5158 2965 5,000
5 salvage 900 100
Total PV Cash
inflows
PV Cash
Outflow
NPV
Profitability Total PV
Index Cash
inflows
/ PV Cash
Outflow
Yr Discount Cash Flow (A) Cash flow (B)
Factor@10%
0 1 -50,000 -78,000
Yr Discount Cash Flow Cash flow (B) pv cash flows A PV Cash flows
Factor@10% (A) B
NPV=0