1. CAPITAL BUDGETING

2. What is capital budget Investments in property , plant and equipment
Any asset which gives economic benefit in future
Asset which generates benefit in future is not treated as current expenditure unless it is of very small value

3. Capital Budget(contd.)
Capital budget may be for the entire asset, for a group of assets comprising a project or for components

4. Capital budgeting methods
Know economic benefits and economic cost in terms of cash flow
Non discounted cash flow - It evaluates a capital budget in absolute cash flow terms
Discounted cash flow method - It evaluates a capital budget in terms of present value cash flow

5. Pay back period
What time is required to get back the initial cash outflow?

6. Discounted pay back period
Recognize time value of money as cash flow is generated over the years
Discount factor may be the weighted average cost capital or marginal cost of capital

7. Net present value Sum of Net Cash flow multiplied by discount factor
In other words, the difference of discounted cash outflow and discounted cash inflow = NPV

8. NPV Accept Reject Criteria
Accept :NPV equal to or greater than zero
This means projects returns equal to or more than cost of capital
Reject : if the NPV is negative What is accept reject criteria

9. Profitability Index
It is ratio of PV of Cash Inflow to PV of Cash outflow
Thus Profitability Index = PV of cash inflows/ PV of cash outflows
Generally when the PI is less than 1, the project be rejected

10. Internal Rate of return
At what rate of interest PV of cash outflow should be equal to PV of cash inflow?

11. Significance of IRR Compare with cost of capital
If IRR >= Cost of capital , accept the project
If IRR < cost of capital , reject it
What was the decision as per NPV ? Same
For evaluating a single project, NPV and IRR give same result

12. PV profile
Calculate NPV at different discount rate and draw a line

13. Comparison between NPV and IRR
Single project : We get same result
Mutually exclusive projects : May or may not get the same result. They will not give the same result for projects with intersecting PV Profiles

14. Cross over discount rate
It is a rate which equates NPV of the competing projects
If WACC is greater than the cross over rate, there is no decision making anomaly under IRR and NPV methods
Contradiction arises at the crossover rate and to the left of it

15. Cross over rate
It is IRR of the differential cash flow

16. Reinvestment rate NPV assumes cost of capital as reinvestment rate
IRR assumes IRR as the re-invetsment rate

17. Projects with unequal lives
NPV approach will not work if the competing projects are having unequal lives
Because there will arise new problems of timing difference

18. Capital budgeting under risk
Correlated cash flow
Unrelated cash flow
Hertz model
Decision tree
Simulated cash flow