Financial Management

PowerPoint Presentation

Capital Budgeting

Should we pursue building of thisplant?

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CAPITAL:- Fixed Assets Used in Production

BUDGET:- Plan of Inflow & Outflow of a case for a defined period

CAPITAL BUDGET:- Focused on the different investment plan CAPITAL BUDGETING:Potential Decision to Long-Term investments are expected to generate cash flow over a series of years.

Features & ProblemsFeatures:-Long-Term EffectsSubstantial CommitmentsIrreversible DecisionsAffect the Capacity & Strength to compete

Problems:-Future UncertaintyTime ElementMeasurement Problem

Types of Capital Budgeting

Capital Budgeting Techniques

Pay Back Period

PAY BACK PERIOD METHODCASH OUT FLOWCASH INFLOWThe number of years required to recover a projects costor How long does it take to get our money back?

Annual Inflows are EqualSuppose Initial Investment = Rs. 10,00,000Annual Cash In-Flow = Rs. 2,50,000 per annumEconomic Life of Machine = 5yrsPAYBACK PERIOD = Initial Investment/Annual Cash In-flow = (10,00,000/2,50,000) = 4 YearsYearsCash In-flow(Rs.)1st2,50,0002nd2,50,0003rd2,50,0004th2,50,0005th2,50,000

Annual Inflows are UnequalSuppose Initail Investment = Rs. 10,00,000Economic Life of Machine = 5yrsPAYBACK PERIOD = Years + (Required Amt / Next Yr Cash Inflow) = 3 + [(10,00,000 9,00,000)]/ 4,00,000] = 3 + (1,00,000/4,00,000) = 3 + 0.25 = 3.25 YearsYearsCash In-flow(Rs.)Cumulative Cash flow1st2,50,0002,50,0002nd3,00,0005,50,0003rd3,50,0009,00,0004th4,00,00013,00,0005th4,50,00017,50,0006th2,50,00020,00,000

Decision RulePay Back Period > Target Period RejectedPay Back Period Specified Rate of Return AcceptedARR< Specified Rate of Return RejectedARR of Machine A < ARR of Machine B Accept Machine B

Net Present Value

The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project.

NPV compares the value of a Rupees today to the value of that same Rupees in the future, taking inflation and returns into account. NPV = Present Value of Cash Inflow- Present Value of Cash Outflow

ExampleInitial Investment = Rs. 8,00,000No. of Years = 5 yrs (N)Rate of Interest = 10% p.a (R) PVF = 1/(1+R)NPresent Value(PV) = (Cash inflow x PVF)NPV = Present Value of Cash Inflow- Present Value of Cash Outflow

NPV = 10,11,300 8,00,000

NPV = 2,11,300

Decision RuleNPV > 0 AcceptedNPV < 0 RejectedNPV of Project A < NPV of Project B Accept Project B

Profitability IndexProfitability index define as the benefits per rupee invested in the proposal This technique is also known as Benefit-Cost RatioThe profitability index method compares the present value of future cash inflows with the initial investment

ExampleInitial Investment = Rs. 10,00,000No. of Years = 5 yrs Rate of Interest = 10% p.a Hence, PI= (PV of Cash Inflow/PV of Cash Outflow) = (10,11,300/10,00,000) = 1.01PI>1, Accept the Proposal

Decision RulePI > 1 AcceptedPI < 1 RejectedPI of Project A < PI of Project B Accept Project B

Internal Rate of ReturnAlso called the time-adjusted rate of return.It is the minimum rate that could be paid for the money invested in a project without losing money.It is also described as the discount rate that results in a projects net present value equaling zero.

Example

Decision RuleIRR > Cost of Raising Capital AcceptedIRR < Cost of Raising Capital RejectedIRR of Project A < IRR of Project B Accept Project B

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