Capital Bugeting

CAPITAL
BUDGETING
PRESENTATION
.
WHAT IS CAPITAL
BUDGETING
Capital budgeting- is defined as the process by which business determine which fixed asset purchase or
project investments are acceptable and which are not.
Capital asset management- requires a lot money,therefore,before making such investments,they must do
capital budgeting to ensure that investment will procure profits for the company.
Capital project- is a set of assets that contingent on one another and are considered together. And this
project may also require the company to increase its investment in its working capital-inventory-cash or
accounts recievable.
Working Capital-is the collection of assets needed for day-to-day operations that support a company`s long
term investment.
INVESTMENT DECISIONS AND OWNERS WEALTH
Managers must evaluate a number of factors in making investment decisions. Not only does the financial
manager need to estimate how much the company`s future cash flows will change if it invest in a
project,but the manager must also evaluate the uncertainty associated with these future cash flow.
Cash flow risk comes from two basic sources;
1.Sale risk-The degree of uncertainty related to the number of units that will be sold and the price of good
or services.
3.Operating risk-The degree of uncertauinty cocering operating cash flows arises from the particular mix of
fixed and variable operating costs.
STAGES IN THE CAPITAL BUDGETING PROCESS
STAGE 2
STAGE 1
Capital budgeting
proposal STAGE 3
Investment
screening and Budgeting
slection approval and
authorization
STAGE 4 STAGE 5
POST
Project tracking COMPETETION
AUDIT
STAGES IN THE CAPITAL BUDGETING
PROCESS
stage 1:Investment Screening and selection-.Projects consistent with the corporate strategy are identified
by production,marketing,research and development management of the company.
stage 2:Capital Budgeting Proposal-A capital budget proposed for the projects surviving the screening and
selection process.
stage 3:Budgeting Approval and Authorization-Projects included in the capital budget are
authorized,allowing further fact gathering and analysis and approved,allowing expenditures for the projects.
stage 4:Project Tracking-After a project is approved,work on it begins.The managers reports periodically on
its expenditures as well as on any revenues associated with it.
stage 5:Post-Completion Audit-No matter the number of stages in company`s capital budgeting
process,most companies inclide some some form of post-completion audit that involves comparison of
actual cash from operations of the project with the estimated cash flow used to justify the peoject.
EVALUATION TECHNIQUE
Payback Period Internal rate of return

refers to the time taken by a proposed project to generate refers to the method where the NVP is zero.In such as
enough income to cover the initial investmentt.The project condition,the cash inflows rate equals the cash out flow
with quickest payback chosen by the company. rate.Although it considers the time value of money,it is one of
the complicated methods.
Formula:Payback period = Initial cash investment/Annual
cashflow
Net present value Profitability index

this method considers the time value of money and attributes provides the ratio of the present value of future cash inflows to the
it to the company`s objective,which is to maximize profits for
initial investment.
its owners.
Formula:Profitability Iindex=Present Value of cash inflo

PAYBACK PERIOD
ADVANTAGES DIS-ADVANTAGES
1.No concrete decision criteria to

1.Simple to compute indicate whether an investment
increases the company's value
2.Provides some 2.Ignores cash flows beyond the
information on the risk of payback period,the time value of
the investment. money and the risk of future cash
flows.
INTERNAL RATE RETURN
1.Tells whether an investment 1.Requires an estimate of the cost of

increase the company's value capital in order to make a decision.
2.Considers all cash flows of the 2.May not give the value-maximizing
project,the time value of money decision when used to compare
and future cash flow risk. mutually exclusive projects.
NET PRESENT VALUE
1.Indicates whether the investment is

expected to increase the company's 1.Requires an estimate of the cost of
value capital in order to calculate the net
2.Considers all the cash flows,the present value.
time value of money, and the risk of 2.Expressed in terms of dollars.
future cash flows.
PROFITABILITY INDEX
1.Tells whether an investment increase 1.Requires an estimate of the cost

the company's value. of capital in order to calculate the
2.Useful in ranking and selecting projects profitability index.
2.May not give the correct
when capital is rationed.
decisiom when used to compare
mutually exclusive projects.
OBJECTIVES OF CAPITAL BUDGETING
Capital Expenditure Control
Organizations need to estimate the cost of
investment as it allows them to control and
manage the required capital expenditures
Selecting Profitable Projects

The company will have to select the most
appropriate project from the multiple
possibilities in front of it.
Identification of source of funds

The business need to locate and select the most
variable and apt source of funds for long-term
capital investment.It needs to compare the
various costs like the cost borrowing and the
cost of Expected profits.
LIMITATIONS OF CAPITAL
BUDGETING
technique that determines if an enchance value
of a project justifies the required
Cash flow investment.The.primary reason to implement
capital budgeting is to achieve forecasting
revenue a project may possibly generate.
capital budgeting works across spans of years.The
shorter duration forcasts may be estimated,the longer
are bound to miscalculated.Therefore, an expanded
time horizon could be a potential problem while
Time Horizon
computing figures with capital budgeting..
method that only requires the business
to repay in the predecided timeframe.
Time Value
the knowledge of discount rates is
essential.The proper estimation and
calculation of which could be Discount Rate
cumbersome task..
Thank You

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CAPITAL

Cash flow risk comes from two basic sources;

Payback Period Internal rate of return

Net present value Profitability index

Formula:Profitability Iindex=Present Value of cash inflo

1.No concrete decision criteria to

1.Tells whether an investment 1.Requires an estimate of the cost of

1.Indicates whether the investment is

1.Tells whether an investment increase 1.Requires an estimate of the cost

Selecting Profitable Projects

Identification of source of funds

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