Meaning - Gerorge A. Wing “ Capital Budgeting is the allocation of long term funds available to the firm among potential uses” Capital Budgeting may be.

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Meaning - Gerorge A. Wing “ Capital Budgeting is the allocation of long term funds available to the firm among potential uses” Capital Budgeting may be called Capital Expenditure Decisions. Capital Budgeting may be called Capital Expenditure Decisions.Characteristics: 1. Long term investment 2. Long term benefits 3. Huge fund investment 4. Huge risk 1

Importance: 1. Ensuring Proper Investment 2. Balancing in Investment 3. Plan for securing fund 4. Competitive Position 5. Assets Addition 6. Assets Acquisition 7. Durability of Assets 8. Increase Production & Profit 9. Sales guaranty 10. Replacement of obsolete Assets 11. Latest Technology 2

Problems of Capital Budgeting in Bangladesh 1. Lack of necessary data 2. Problem of feasibility study 3. Fluctuation in Price Level 4. Problem of studying available alternatives 5. Impact of Investment Policy 6. Affect of Foreign Policy in Investment 7. Lack of necessary fund 8. Lack Investment Environment 9. Changes in economic condition 10. Difficulties of estimating Cost and Benefits 3

Differences between Capital Budgeting and Capital Rationing Capital Budgeting Capital Rationing 1. Long term fund in long term investment 2. Important Decision 3. Long term plan 1. Long term fund in current investment 2. Proper Financing 3. Short term plan 4

Some factors in Capital Expenditure Decisions 1. Opportunity Cost 2. Interest Cost 3. Depreciation 4. Net Cash Outlay = NCO 5. Anticipated Project Life 6. Net Cash Benefit = NCB 7. Residual and Salvage Value 8. Income Tax and Capital Investment 5

Methods of Capital Budgeting: A. Conventional or Traditional Method: 1. Return on Investment Method (ROI) 2. Pay back period Method (PBP) B. Discounted Cash flow method 1. Internal Rate of Return (IRR) 2. Net Present Value Method (NPV) 3. Profitability Index Method 4. MAPI Method (Machinery Allied Products Institute) 5. Pay back reciprocal Method 6

A manager is considering three mutually exclusive investment project A,B and C. Each promising a cash flow of Tk. 20, 00, 000 per year for an initial investment of Tk. 10, 00, 000 useful lives are as follows Project Years A5 B6 C7 Required 1. Compute the payback period for each project. If payback time is the sole criterion for the decision which project is most desirable? 2. Which project offers the highest return? Problem # 01 7

ParticularsProjects ABC 1. Capital cost (NCO) Tk. 2. Anticipated life years 3. Annual Net cash benefit (NCB) 4. Pay back period= NCO/NCB 5. Total NCB Over Project life 6. Rate of Return = Annual NCB/NCO × , 00, , 00, , 00, % 6 2, 00, , 00, % 10, 00, , 00, , 00, % Solution Statement Showing the Profitability 8

Recommendation: i. If we use the pay back time as the sole criterion for measuring investment worth, we shall have to be indifferent to each of the projects A,B and C. Because the pay back period is same for all. But if we consider the total NCO over project life then the project C is the most profitable, for it earns TK. 4, 00, 000 (14, 00, , 00, 000) more than A and TK. 2, 00, 000 (14, 00, , 00, 000) more than B ii. The rate of return is same for A,B and C. So we are, like pay back method, indifferent between them. They will earn the same rate of return. 9