1. CAPITAL BUDGETING Involves decision to invest current funds of a business concern most effectively in long-term activities, in anticipation of an expected flow of future benefits over a series of years in future.

2. CAPITAL BUDGETING Importance of Capital Budgeting:- 1.Long term implications for the firm 2.Involve committing large funds 3.They are irreversible decisions. 4.Among the most difficult decisions to make.

3. CAPITAL BUDGETING Features of Capital Investment Decisions:- 1.Exchange of current funds for future benefits. 2.Funds invested in long-term assets 3.Future benefits will occur over a series of years.

4. CAPITAL BUDGETING INVESTMENT EVALUATION CRITERIA: INVOLVES:- 1.ESTIMATION OF CASH FLOWS. 2.ESTIMATION OF REQUIRED RATE OF RETURN 3.APPICATION OF A DECISION TECHNIQUE FOR MAKING THE CHOICE

5. CAPITAL BUDGETING DECISION- TECHNIQUES:- TRADITIONAL 1.PAY-BACK METHOD 2.AVERGE RATE OF RETURN(ARR)- RETURN ON INVESTMENT METHOD

6. CAPITAL BUDGETING DECISION-TECHNIQUES:- DISCOUNTED-CASH FLOW(DCF)- TIME-ADJUSTED METHODS 1.NET PRESENT VALUE METHOD(NPV) 2.INTERNAL RATE OF RETURN(IRR) 3.TERMINAL VALUE METHOD 4.PROFITABILITY INDEX

7. CAPITAL BUDGETING SOME CAPITAL BUDGETING DECISIONS 1.Mechanisation of a Division 2.Replacing or modernising a process 3.Mutually exclusive decisions in selecting a machine 4.Buy or Lease decisions-comparative profitability 5.Business expansion by capital investments.

8. CAPITAL BUDGETING INVESTMENT DECISIONS:- PAY-BACK METHOD PAY BACK PERIOD (PBP)= TOTAL CASH OUTFLOWS ANNUAL CASH FLOWS FROM OPERATIONS If Rs. 60000 invested today yields annual cash inflow of Rs. 15000 for 6 years, the Pay Back Period= 60000/15000 = 4 years. PROJECT WITH LEAST PBP IS ACCEPTED

9. CAPITAL BUDGETING PAY BACK METHOD:- LIMITATIONS:- 1.Does not give weightage to total earnings 2.Time value of money not recognised MERITS:- a.Very simple and popular. b.Good in unstable conditions

10. CAPITAL BUDGETING AVERAGE RATE OF RETURN(ROI) METHOD :- Average annual profit after Tax x 100 Average investment over the life of the product Average Profit=Sum of Profits over the life of the asset / No. of years. Average investment= Original Investment-scrap value / 2

11. CAPITAL BUDGETING ARR METHOD:- Advantages:- Can be readily calculated Simple in application Entire stream of income is considered Useful as a good performance evaluation and control measure.

12. CAPITAL BUDGETING ARR METHOD:- SHORTCOMINGS:- 1.CASH FLOWS IGNORED 2.TIME VALUE OF MONEY IGNORED 3.AVERGE RETURNS vs. CURRENT RETURNS 4.LESS USEFUL FOR INVESTMENT DECISIONS.

13. CASH BUDGETING DISCOUNTED CASH FLOW METHODS:- NET PRESENT VALUE METHOD:- The difference between present value of cash inflows and cash outflows. The firm’s opportunity cost of capital being the discount rate. If Positive (> 0) = ACCEPT If Negative (< 0) = REJECT

14. CAPITAL BUDGETING PV OF FUTURE CASH INFLOWS= s (1 + r)^n Where s = Cash inflow expected r = rate of interest n = no. of years. i.e. S = P (1+ r)^n

15. CAPITAL BUDGETING NPV METHOD:- MERITS:- 1.Considers all cash flows. 2.True measure of profitability 3.Time value of money reckoned 4.Consistent with wealth maximisation principle

16. CAPITAL BUDGETING NPV METHOD:- DE-MERITS:- 1.TEDIOUS ESTIMATES 2.DISCOUNT RATE-COMPUTATION 3.SENSITIVE TO DISCOUNT RATES STILL REGARDED AS MOST EFFECTIVE

17. CAPITAL BUDGETING IRR METHOD( YIELD METHOD): IRR is the discount rate which equates the present value of an investment’s cash inflows and outflows. IF IRR > K(COST)-----ACCEPT IF IRR = K(COST)-----MAY ACCEPT IF IRR < K(COST)-----REJECT IF IRR = K, NPV = 0

18. CAPITAL BUDGETING IRR METHOD:- MERITS:- 1.Considers all Cash Flows 2.True measure of profitability 3.Time value reckoned

19. Capital Budgeting IRR METHOD:- DE-MERITS:- 1.TEDIOUS METHOD. 2.RELATIVELY DIFFICULT TO COMPUTE.

20. CAPITAL BUDGETING NPV vs IRR:- INTERPOLATION METHOD:- When one comes across two rates of NPV- One positive NPV & One negative NPV IRR by Interpolation:- Lower rate + NPV at Lower rate x rate differential. Absolute difference of both NPVs

21. CAPITAL BUDGETING IRR by INTERPOLATION- e.g.:- At 10% say NPV of cash flows = Rs. 200( +) At 12% say NPV pf cash flows = Rs. 210( -) IRR = 10% + 200 x ( 12-10) (200 + 210) 10% + 0.98 = 10.98%

22. CAPITAL BUDGETING TERMINAL VALUE METHOD:- IMPROVED DCF METHOD WITH EACH CASH FLOW RE-INVESTED FOR REMAINING YEARS. If re-invested Cash Flow > Outflow=Accept If re-invested Cash Flow < Outflow=Reject

23. CAPITAL BUDGETING PROFITABILITY INDEX:- Present Value of Cash Inflows Present Value of Cash Outflows It is a relative measure and provides solution for projects requiring initially different levels of investment APPLY WHEN NPV IS SAME IN 2 CASES

24. CAPITAL BUDGETING PROFITABILITY INDEX FOR PROJECT APPRAISAL Project-AProject-BProject-C Cash Outflows100002000040000 PV –Inflows140002500052000 NPV 4000 500012000 RANKING III II I P. INDEX1.401.251.30 RANKING BY PI I III II

25. CAPITAL BUDGETING DU-PONT ANALYSIS ROI ROI= PROFITABILITY x INVENTORY TURNOVER Net Profit / Sales x Sales / Total Assets = Net Profit / Total Assets = ROI Shows inter-action of profitability and activity Ratios.

26. CAPITAL BUDGETING DU-PONT ANALYSIS ROI It shows that performance can be improved Either by- (a)Generating more sales volume per rupee of investment. OR (b)Increasing the profit margin per rupee of sales. A CENTRAL MEASURE OF OVERALL PROFITABILITY AND OPERATIONAL EFFICIENCY