Capital-Budgeting

CAPITAL BUDGETING:

CAPITAL BUDGETING SUBMITTED BY :- PRAGYA SHARMA B.B.A VTH SEM

Capital Budgeting:

Capital Budgeting Capital budgeting(or investment appraisal) is the process of evaluating and selecting long-term investments that are in line with the goal of investors’ wealth maximization. We want to invest in projects where the value of the future returns is greater than the cost. In Capital Budgeting involves:- Evaluating investment project proposals that are strategic to business overall objectives Estimating and evaluating how much cash flows incurred for each of the investment proposals Selection an investment proposal that maximizes the return to the investors

PURPOSE OFCAPITAL BUDGETING:

PURPOSE OFCAPITAL BUDGETING ( i )Substantial expenditure: (ii)Long time period: (iii)Irreversibility: (iv)Complex decision

Methods are used in capital budgeting:

Methods are used in capital budgeting Accounting rate of return Net present value Internal rate of return Pay Back

Accounting or Average rate of return:

Accounting or Average rate of return The term “ Average annual net earnings” is the average of the earnings (after depreciation and tax) over the whole of the economic life. One may calculate " Average annual net earnings " before tax. Such rate is known as pre - tax accounting rate of return. If ARR = OR > required rate of return then acceptable If ARR is < the desired rate then rejected When comparing investments, the higher the ARR, the more attractive the investment Formula :- where

Net present value:

Net present value The net present value is the difference between present value of benefits and present value of costs. If the net present value is positive the conclusion is favorable to the decision to go ahead with the project but if it is negative, the project is rejected. Accept/Reject Criterion : Where NPV > Zero accept the proposal NPV = Zero accept the proposal NPV < Zero reject the proposal NPV = Net Present Value The net present value technique is a discounted cash flow method that considers the time value of money in evaluating capital investments. Net present value = Present value of net cash flow - Total net initial investment

Advantages :

Advantages NPV method takes into account the time value of money. The whole stream of cash flows is considered. The net present value can be seen as the addition to the wealth of share holders. The NPV uses the discounted cash flows i.e., expresses cash flows in terms of current rupees. The NPVs of different projects therefore can be compared. It implies that each project can be evaluated independent of others on its own merit

Limitations:

Limitations It involves difficult calculations. The application of this method necessitates forecasting cash flows and the discount rate. Thus accuracy of NPV depends on accurate estimation of these two factors which may be quite difficult in practice. The ranking of projects depends on the discount rate.

Internal rate of return:

Internal rate of return The internal rate of return method considers the time value of money. This method measures the rate of return which earnings are expected to yield on investment. Acceptance rule:- IRR = or > the cut of rate then project is accepted. When it is < the cut of rate then project is rejected.

Pay back method:

Pay back method This method is based on the principal that every capital expenditures pays itself back within a certain period out of the additional earrings generated from the capital assets. Formula:- cash outlay of the project or original cost of the asset Annual cash flow Evaluation of a project:- if project doesn’t pay back itself within period specified – it is rejected …