Capital budgeting’ OF FINANCIAL MANAGEMENT

‘CAPITAL BUDGETING’

Guided by- presented by-

Mr. Atul Kharad sir vivek chandraker

mha & m 3rd sem

Contents- Introduction Definition Cases of capital budgeting Concept of capital budgeting Importance of capital budgeting Process of capital budgeting Techniques of capital budgeting Merits and demerits of capital budgeting Accept and reject criteria References

INTRODUCTION- The finance manager concerned with the investment decision ,

popularly known as capital budgeting decision, require comparison of cost against benefits over the long period.

For Example :

The deployment finances of additional plant and equipment cannot be recovered in the short run. Such investment may affect revenues for the period ranging from 2 to 20 years or more.

Such investment decision involve a careful consideration of various factors profitability, safety, liquidity and solvency.

DEFINITION-

Capital budgeting is the planning process used to determine whether an organizations long term investments such as new machinery , replacement machinery ,new plants new products and research development projects are worth the funding of cash through the firms capitalization structure (debt ,equity or retained earnings)..

CASES OF CAPITAL BUDGETING-

Replacement

Expansion

Diversification

Research and development

Miscellaneous

CONCEPT OF CAPITAL BUDGETING-

The term capital budgeting refers to long term planning for proposed outlays (Expenditure)and their financing.

It may defined as “the firms formal financial process for the acquisition and investment of capital”

It is the decision making process by which the firm evaluate the purchase of major fixed asset.

IMPORTANCE OF CAPITAL BUDGETING-INVOLVEMENT OF HEAVY FUND-

Capital budgeting decisions require large capital outlays. It is therefore absolutely necessary that the firm should carefully plan they are put to most profitable use.

LONG TERM IMPLICATION-

The effect of capital budgeting decision will be felt by the firm over a long period and therefore they have decisive influence on the rate and direction of the growth of the firm.

CONT..

IRREVERSIBLE DECISION-

In most cases, capital budgeting decisions are irreversible. This is because it is very difficult to find a market for the capital assets. The only alternative will be to scrap the capital assets so purchased or sell them at a substantial loss in the event of the decision being proved wrong.

MOST DIFFICULT TO MAKE-

The capital budgeting decision require an assessment of future events which are uncertain . It is really difficult task to estimate the probable future events, the probable benefits and cost accurately in quantitative terms because of economic ,political, social , and technological factors.

PROCESS OF CAPITAL BUDGETING-

Capital budgeting is a difficult process to the investment of available funds. The benefit will attained only in the near future but, the future is uncertain.

Identification of various investments proposals Screening or matching the proposals Evaluation Fixing priority Final approval Implementing Performance review of feedback

TECHNIQUES OF CAPITAL BUDGETING-

Pay Back Method

Accounting rate of return

Net Present Value

Profitability Index

PAY BACK PERIOD- The payback period is the length of time required to recover

the initial cost of the project. The payback period is the length of time required to recover the initial cost of the project. The payback period therefore can be looked upon as the length of time required for a proposal to break even on its net investment.

CALCULATION OF PAYBACK PERIOD-

When Annual Inflow are Equal. When the Annual Cash Inflow are Unequal

MERITS- Simple to calculate Liquidity Indications Break even of investment can be calculated.

DEMERITS-

Ignores the profitability factor.

Its is the method of recovery.

Ignores salvage Value.

Ignores the time value of money.

ACCEPT / REJECT CRIETERIA-

If the actual pay-back period is less than the predetermined pay-back period, the project would be accepted. If not, it would be rejected.

EXAMPLE-

CONT…

AVERAGE RATE OF RETURN- Average rate of return means the average rate of return or profit taken for

considering the project evaluation. This method is one of the traditional methods for evaluating the project proposals:

MERITS-

1.It is easy to calculate and simple to understand. 2. It is based on the accounting information rather than cash inflow. 3. It is not based on the time value of money. 4. It considers the total benefits associated with the project. DEMERITS-

It ignores the time value of money. It ignores the reinvestment potential of a project.

ACCEPT / REJECT CRITERIA-

If the actual accounting rate of return is more than the predetermined required rate of return, the project would be accepted. If not it would be rejected.

PROFITIBILITY INDEX- It is also a time adjusted method of evaluating investment proposal .

Profitability index also called as Benefit- Cost ratio or desirability factor is relationship between present value of cash inflow and the present value of cash outflow.

FORMULA-

Present Value of Cash Inflow

Profitability Index =

Present Value of Cash Outflow

/Investment

MERITS- It is consistent with goal of maximizing the shareholders wealth. It uses cash flow. It recognized the time value of money.

DEMERITS-

The main demerit of this method is that is requires detailed long term forecast of incremental benefits and costs. Its also have the difficulty in determining appropriate discount rate.

REFERENCES- FINANCIAL MANAGEMENT

BY PROF. DR. SATISH INAMDAR

FINANCIAL MANAGEMENT

BY C. PARAMASIVAN

FINANCIAL MANAGEMENT

BY KHAN & JAIN

THANK YOU….