CAPITAL BUDGETING

CHAPTER I
INTRODUCTION
INTRODUCTION
CAPITAL BUDGETING
Capital budgeting is a required managerial tool. One duty of a financial
manager is to choose investments with satisfactory cash flows and rates of return.
Therefore, a financial manager must be able to decide whether an investment is worth
undertaking and be able to choose intelligently between two or more alternatives. To do
this, a sound procedure to evaluate, compare, and select projects is needed. This
procedure is called capital budgeting.
In the form of either debt or equity, capital is a very limited resource. There is a
limit to the volume of credit that the banking system can create in the economy.
Commercial banks and other lending institutions have limited deposits from which they
can lend money to individuals, corporations, and governments. In addition, the ederal
!eserve "ystem requires each bank to maintain part of its deposits as reserves. #aving
limited resources to lend, lending institutions are selective in e$tending loans to their
customers. %ut even if a bank were to e$tend unlimited loans to a company, the
management of that company would need to consider the impact that increasing loans
would have on the overall cost of financing.
The argument that capital is a limited resource is true of any form of capital, whether
debt or equity &short'term or long'term, common stock( or retained earnings, accounts
payable or notes payable, and so on. )ven the best'known firm in an industry or a
community can increase its borrowing up to a certain limit. Once this point has been
reached, the firm will either be denied more credit or be charged a higher interest rate,
making borrowing a less desirable way to raise capital.
aced with limited sources of capital, management should carefully decide
whether a particular project is economically acceptable. In the case of more than one
project, management must identify the projects that will contribute most to profits and,
consequently, to the value &or wealth( of the firm. This, in essence, is the basis of capital
budgeting.
CAPITAL BUDGETING
Capital %udgeting is the process of allocating capital within the firm to the best use. This
decision process is carried out by applying a number of *iscounted Cash low &*C(
decision models. The four standard models usually employed include+

,-. ,et -resent .alue
-I -rofitability Inde$
I!! Internal !ate of !eturn
/I!! /odified Internal !ate of !eturn

"ince all four methods are based on *C methods, all are superior to non'*C based
methods such as the -ayback method. ,ot all of these methods are equally valuable in all
situations. There are some theoretical weaknesses with the I!! reinvestment rate
assumption and some practical weaknesses associated with the possibility of multiple
I!!0s when the cash flows of a project change sign over time. The /I!! method
addresses the reinvestment rate assumption weakness by the possibility of multiple I!!0s
still remains. The ,-. is the most appealing method since it presents the present value
dollar addition to the wealth of the firm associated with a project without the theoretical
or practical shortcomings of the I!!. The ,-.0s related measure, the -I, allows for
comparison of projects of different si1es within the ,-. framework. Typically, when
analy1ing a project, all four methods are applied as their results provide different types of
information. requently all four methods provide the same accept 2 reject
recommendation but the I!! methods sometimes does provide a recommendation that
conflicts with the other methods. These topics are discussed in greater detail in the
te$tbook readings.

CAPITAL BUDGETING
A Reminder: !cu" !n incremental a#ter$ta% ca"& #l!'"(
irst consider each project against the alternative choice of doing
nothing. Incremental cash flows are then easily identified.
3e then compare different alternative investments based on ,-., -I, I!!, and
/I!! and the relationship between investment choices.
4s an advanced analysis, we consider alternative uses of e$isting
facilities. "pecifically, we identify any secondary uses of e$isting facilities and
estimate all incremental after'ta$ cash flows associated with this alternative. This
alternative use becomes just another project that is analy1ed and considered.
3e can then include this new analysis into our comparison.

)!me cauti!nar* n!te":
/ake sure all ta$ implications are considered.
/ake sure all known future salvage related cash flows are included.
/ake sure all incremental cash flows are include+
/ake sure sunk costs are ignored.
/ake sure we ignore all interest and other financing costs.
Capital Budgeting De#initi!n5
/ost small to medium si1ed companies have no idea how to approach capital
investments. They treat it as if it were an operating budget decision rather than a long'
term, strategic decision that will impact their cash flow, efficiency of their daily
operations, income statement, and ta$able income for years to come. They need your help
understanding the importance of and then making the right capital budgeting decisions.
Capital budgeting decisions relate to decisions on whether or not a client should invest in
a long'term project, capital facilities and2or capital equipment2machinery. Capital budget
decisions have a major effect on a firm0s operations for years to come, and the smaller a
firm is, the greater the potential impact, since the investment being made could represent
a substantial percent of the firm0s assets.
Capital Pr!+ect E%ample"5
CAPITAL BUDGETING
Capital projects are usually identified by functional needs or opportunities, although
many are also identified as a result of risk evaluation or strategic planning. "ome typical
long'term decisions include whether or not to+
6 %uy new office equipment, cars or trucks7
6 4dd to or renovate e$isting facilities, including the purchase of new capital
equipment2machinery7
6 )$pand plant or process operations7
6 Invest in facilities for a new product line or to e$pand services7
6 Continue or discontinue an e$isting product line7
6 !eplace e$isting capital equipment2machinery with new equipment2machinery7
6 Invest in software to meet technology'based needs or systems designed to help improve
process and2or efficiency7
6 Invest in !8* or intangible assets7
6 %uild or e$panding a foreign or satellite operation7
6 !eorgani1e assets or services7 or,
6 4cquire another company.
Capital investment &or, e$penditure( decisions are more commonly referred to as capital
budgeting decisions since they involve resource allocation, particularly for the production
of future goods and services, and the determination of cash out'flows and cash'inflows,
which need to be planned and budgeted over a long period of time. It is important that
CAPITAL BUDGETING
you get involved right from the start to guide them through this process since this is a
very complicated accounting issue.
Capital Budgeting P&a"e"5
The phases of the capital budgeting process include+
6 *escription of the need or opportunity7
6 Identification of alternatives7
6 )valuation of the options and the relevant cash flows of each7
6 "election of best alternative7 and
6 Conducting a post'completion audit of the projects.
Identi#*ing Capital Budgeting Need"5
The first step is to identify the need or opportunity. This is usually done at the mid'
management level and is the result of a shared vision of company goals and strategies
coupled with a 9where the rubber meets the road9 perspective of 9local9 clients needs,
tastes and behavior. They see a need or opportunity and communicate it to senior
management, usually in the form of proposals which both include identification of the
need or opportunity, and potential solutions and2or recommendations. "enior management
then evaluates the merit of each proposed opportunity and makes a determination of
whether or not to look into it further.
3hile project need identification is usually a de'centrali1ed function, capital initiation
and allocation decisions tend to remain a highly centrali1ed undertaking. The reason for
this revolves around the need for capital rationing, especially when funds are limited and
upper'management wishes to ma$imi1e its returns2benefits from any capital projects
undertaken.
CAPITAL BUDGETING
The information needed to make this determination usually comes from both internal and
e$ternal sources, and is based on both financial and non'financial considerations.
Interestingly enough, the factors e$amined in this process can be both firm'specific and
market'based in nature. It is that this point that companies should be seeking qualified
financial guidance since the consequences of both a poor decision and of the
implementation of a good decision can be far'reaching.
Capital Pr!+ect E,aluati!n5
:pper management must develop an objective methodology so that alternate capital
projects can be evaluated on a reasonable basis. %oth quantitative and qualitative issues
must be considered and the whole organi1ation should be used as a resource.
/arketing should provide data on sales trends, new demand and opportunities for new
products. /anagers at every level should be identifying resources that are available to
upper'management that may lead to the use of e$isting facilities to resolve the need2take
advantage of the opportunity. They should also be communicating any needs they2their
departments or divisions have that should be part of the capital decision. inancial
analysts, or in their absence, qualified e$ternal financial e$perts such as your firm, should
be involved in identifying the target cost of capital, the evaluation of startup costs and the
calculation of cash flows for those projects chosen for evaluation purposes. Calculating
the appropriate discount rate and calculating conservative cash flows is a critical part of
this process that is best served by an independent accounting firm that can look at the
project2these issues impartially. )stimation bias can be dangerous.
The objective is to evaluate &predict( how well each capital asset alternative will do and to
determine if the net benefits to the firm are consistent with the required capital allocation,
given the scarcity of resources most firms are faced with.
-ea"urement" U"ed in Capital Budget"5
CAPITAL BUDGETING
The purpose of the evaluation phase is to predict how well a new asset will benefit the
firm. -ossible measures, which you should help the firm develop, that should be
considered include+
6 ,et income managers evaluate the incremental increase in accounting net income
between alternatives7
6 ,et cash flow this is the most widely used measure7 this measure looks at the actual
cash flows &out and then in( resulting from the capital investment for each alternative7
these need to be evaluated for both overall value &several techniques will be discussed
ne$t( and from the standpoint of the effect on daily cash flow and the ability of the firm to
meet its financial obligations in a timely manner7 projects with high projected future
returns may not be as attractive when adjusted for the time value of money or the costs
involved in borrowing funds to meet operating obligations such as payrolls and accounts
payable7
6 Cost savings many capital investments are not designed to generate revenues directly
but are, instead, designed to save costs and increase productivity7 these projects are best
evaluated on the basis of incremental savings generated7
6 )quality of cash flows cash flows tend to vary from year to year7 the timing of cash
flows may be an important consideration to the firm
6 "alvage value and functionality of an e$isting asset when replacing it with a new asset
while the historical cost of an e$isting asset is not relevant to a capital budgeting decision,
the net proceeds from disposal of the e$isting equipment is7 so is the question of how well
e$isting equipment operates given that capital budgeting decisions are only concerned
with incremental costs and incremental savings2profits7
6 Depreciati!n, earnings and income ta$ effects need to be considered based on the form
of the firm &sole proprietorship, partnership, corporation, etc.(, and the differences in the
financial and ta$ accounting treatments available to the firm, especially as they apply to
salvage value, useful lives and allowed depreciation methods, and, consideration of the
marginal ta$ rate &which may vary from country to country(7 most firms fail to consider
this cost or choose a ta$ or financial accounting treatment that does not ma$imi1e the
CAPITAL BUDGETING
firm0s return on invested capital7
6 In#lati!n the effects of inflation need to be considered in estimating cash flows as well,
especially if is projected to increase in future periods and varies between capital projects
being considered7
6 !isk considerations political risk, monetary risk, access to cash flows, economic
stability, and inflation should all be considered in the evaluation process since all are
hidden costs in the capital budgeting process7 and,
6 Interest and the cost of capital the venture has to have a return that is greater than its
cost of capital, adjusted for ta$ benefits, if any.
The firm should also make a subjective decision as to its preferences in terms of
characteristics of projects in addition to the regular selection criteria it has set. or
e$ample, does the firm prefer+
6 -rojects with small initial investments; )arlier cash flows; Or, perhaps, shorter payback
times;
6 ,ew projects or e$pansion of the e$isting operations;
6 *omestic projects or foreign operations;
6 If the firm is risk neutral, would the prospects of additional potential cash flows in
riskier investments make a capital project more attractive;
E,aluating Ri". !# Capital Pr!+ect"5
!isk also needs to be analy1ed carefully, regardless of which valuation method is used to
evaluate the project. The more popular risk'assessment techniques include "ensitivity
4nalysis, "imple -robability 4nalysis, *ecision'Tree 4nalysis, /onte Carlo "imulations
and )conomic .alue 4dded &).4(+
6 "ensitivity 4nalysis considers what will happen if key assumptions change and
identifies the range of change within which the project will remain profitable7
CAPITAL BUDGETING
6 "imple -rofitability 4nalysis assesses risk by calculating an e$pected value for future
cash flows based on their probability of success to future cash flows7
6 *ecision'tree 4nalysis builds on "imple -rofitability 4nalysis by graphically outlining
potential scenarios and then calculating each scenario0s e$pected profitability based on the
project<s cash flow2net income7 this technique allows managers to visuali1e the project
and make more informed decisions, although decision trees can become very complicated
considering all the scenarios that should be considered &e.g., inflation, regulation, interest
rates, etc.(7
6 /onte Carlo "imulations use econometric2statistical probability analyses to calculate
risk7 and,
).4, which is growing in popularity, is a performance measure that adjusts residual
income for 9accounting distortions9 that decrease short'term income but have long'term
effects on shareholder wealth &e.g., marketing programs and !8* would be capitali1ed
rather than e$pensed under ).4(.
Once the risk has been assessed, which valuation method should the firm2you use for a
project; The answer depends on considerations such the nature of the investment &the
timing of its cash flows, for instance(, uncertainty about the economy and the time value
of money if it is a very long term capital project.
Capital Pr!+ect E,aluati!n -et&!d"
T&e #!ur m!"t p!pular met&!d" are:
6 The -ayback -eriod /ethod, which favors earlier cash flows and selects projects based
on the time it takes to recover the firm0s investment7 weaknesses in this method include
the facts it does not consider cash flows after the payback period and it does not consider
the time values of money7 a common practice is to use this method to select from projects
with similar rates of return that have been evaluated using a discounted cash flow &*C(
CAPITAL BUDGETING
method &e.g., this is often referred to as the -ayback /ethod based on *iscounted Cash
lows or %reak')ven Time /ethod(7
6 The 4ccounting !ate of !eturn &4!!( /ethod, which uses accounting income2=44-
information, is calculated as the average annual income divided by the initial or average
investment7 the projected return is normally compared to a target 4!! based on the firm0s
cost of capital, the company0s past performance and2or the riskiness of the project.
6 The ,et -resent .alue&,-.( /ethod, which is based on the time value of money and is
a popular *C method7 the ,-. /ethod discounts future cash flows &both in' and out'
flows( using a minimum acceptable cost of capital &usually based on the weighted
average cost of capital or 34CC, adjusted for perceived risk( that is referred to as the
9hurdle rate97 the ,-. is as the difference between the present value of net cash inflows
and cash outflows, and a >? answer implies that the project is profitable and that the firm
recovered its cost of capital7 and,
6 The Internal !ate of !eturn &I!!( /ethod, which is based on the time value of money,
calculates the interest rate that equates the present value of cash outflows and cash
inflows7 this calculated rate of return is then compared to the required rate of return, or
hurdle rate, to determine the viability of the capital projects.
)!#t C!"t" and Bene#it" in Capital Budgeting
Other considerations the firm2you should consider as part of the valuation process are
9soft9 costs and benefits. "oft costs and benefits are difficult to quantify by are real non'
the'less. )$amples of soft costs might be a capital investment in a manufacturing process
that results in added pollution to the atmosphere. 4 soft benefit might be the enhancement
of a firm0s overall image as a result of investing in !8* for high'tech products. Ignoring
soft benefits and costs can lead to strategic mistakes, especially if you are talking about
investments in advanced manufacturing technology. "oft benefits and costs need to be
CAPITAL BUDGETING
estimated and then included as part of the method used to determine if a capital project is
desirable.
P!"t C!mpleti!n Pr!+ect E,aluati!n
Once the project has been chosen and put into operation, a post completion audit of the
project should be undertaken by a qualified financial services firm, such as yours, which
can evaluate the project objectively. This audit by an independent party will function as a
control mechanism to ensure that the capital project is performing as e$pected and, in the
event it is not, to make it easier to terminate the project by eliminating any bias of those
involved in the project. It will also serve as a learning mechanism for upper management
as they compare actual performance to e$pected results, and improve the processes and
estimates they use in future investment decisions.
It should be noted that this control mechanism, which can be e$pensive, is essential to the
success of future capital investment decisions, especially considering the long life of most
capital projects.
One final word regarding implementation of this control mechanism7 successful post'
completion auditing processes require that upper management understand that the purpose
of the audit is to learn from past e$periences,. /anagers should not be penali1ed for the
decisions they made but should, instead, be given the opportunity to learn from them.
)COPE O THE )TUD/:
"CO-) The study covers the calculation of payback period, 4verage rate of
return, ,et present value, -rofitability inde$, internal rate of return etc. 4lso the study
includes the decisions as to be made for investment process. These percentages help in
analy1ing the funds for investment purpose.
CAPITAL BUDGETING
NEED OR THE )TUD/:
Capital budgeting decisions are of paramount importance in financial
decision'making. "pecial care should therefore be taken in making these decisions on
account of following reasons.
#eavy investments.
@ong term commitment on funds
Irreversible decisions
@ong term impact of profitability
CAPITAL BUDGETING
/ost difficult to make.
3ealth ma$imi1ation of shareholders.
Cash forecast.

OB0ECTI1E) O THE )TUD/
The objectives of the study are+
To understand the need of organi1ations to identify and invest in high quality
capital projects.
To evaluate capital projects using traditional methods of investment appraisal and
discounted cash flow methods.
To evaluate the investment proposal by using capital budgeting techniques.
CAPITAL BUDGETING
-ETHODOLOG/ O THE )TUD/
The information for the study is obtained from two sources namely.
-rimary "ources
"econdary "ources
Primar* )!urce":
It is the information collected directly without any references. It is mainly through
interactions with concerned officers 8 staff, either individually or collectively7 some of
the information has been verified or supplemented with personal observation. These
sources include.
Thorough interactions with the various department /anagers.
CAPITAL BUDGETING
)ec!ndar* )!urce":
This data is from the number of books and records of the company, the annual
reports published by the company and other maga1ines. The secondary data is obtained
from the following.
Collection of required data from annual records, monthly records, internal
records
Other books and Aournals and maga1ines
4nnual !eports of the company
Limitati!n"
a( @ack of knowledge. "ome of the lack full'fledged knowledge of the concept and
its difficult to collect a specific opinion from them.
b( Time limitation. The duration of the project is short to collect the required
information accurately.
c( #ow money is acquired and from what -raga tools;
d( #ow individual capital project alternatives are identified and evaluated;
e( #ow minimum requirements of acceptability are set;
CAPITAL BUDGETING
CAPITAL BUDGETING
CHAPTER II
RE1IE2
O
LITERATURE
CAPITAL BUDGETING
INANCIAL DECI)ION IN A IR-
CAPITAL BUDGETING DECI)ION
The first and perhaps the most important decisions that any firm has to make is to
define the business or businesses that is wants to be this decision has a significant bearing on
how capital is allocated in the firm.
CAPITAL )TRUCTURE DECI)ION)
Once a firm has decided on the investment projects it wants to undertake, it has to
figure out ways and means of financing them. The key issues in capital structure decisions are+
what is the optimal debt'equity ration of the firm; 3hich specific instruments of equity and
debt finance should the firm employ; 3hich capital markets should the firm access;
DI1IDEND DECI)ION)
*etermining the dividend policy is an important task. The dividend decision involves
what percentage of profit to be paid of the shareholder. 4 number of factors affect the
dividend decision such as market price of the share earnings, ta$ positions etc.
2OR3ING CAPITAL -ANAGE-ENT
3orking capital management, also referred to as short'term financial management,
refers to the day'to'day financial activities that deal with current assets &inventories, debtors,
short'term holdings of securities, and cash( and current liabilities &short'term debt, trade
creditors, accruals and provisions(.
The key issues in working capital management are+
3hat is the optimal level of inventory for the operations of the firm;
#ow much cash should the firm carry on hand; )tc
4 business proposal regardless of whether it is a new investment or acquisition of
another company or restructuring initiative'raises the value of the firm only if the present
value of the future stream of net cash benefit e$pected from the proposal is greater than the
initial cash outlay required to implement the proposal.
CAPITAL BUDGETING
RI)3$RETURN TRADEO
The alternative course of action typically has different risk'return implications. 4 large
plant may have a higher e$pected return and a higher risk e$posure, where a small plant has
may have a lower e$pected return and a lower risk e$posure. 4 higher debt'equity ratio,
compared to a lower debt'equity ratio, /ay reduced the cost of capital but e$pose the firm to
greater risk..
LONG TER- )OURCE) O INANCE
It is natural phenomenon that the firm is always in deficit of funds. There are two
methods of rising of funds.
45 LONG TER- )OURCE)
65 )HORT TER- )OURCE)
Capital budgeting decisions involve long'term funds. The different long'term sources of
finance generally followed by companies are.
E7UIT/ CAPITAL:$
)quity capital represents ownership capital, as equity shareholders collectively own the
company. They enjoy the rewards and bear the risk of ownership. #owever, their liability of
the owner in a proprietary firm and the partners in a partnership concern is limited to their
capital contributions.
CAPITAL BUDGETING
INTERNAL ACCRUAL):$
The internal accruals of a firm consist of depreciation charges and retained earnings.
*epreciation represents the allocation of capital e$penditure to various periods over which the
capital e$penditure is e$pected to benefit the firm. !etained earnings are that portion of equity
earnings, which are ploughed back to the firm. %ecause retained earnings are the sacrifice
made by the equity shareholders, they are referred to as internal equity.
PREERENCE CAPITAL:$
It represents a hybrid form of financing as it has many features of both ordinary shares
and debenture. -reference share may be issued with or without maturity date. The holder of
preference shares get divided at a fi$ed rate and have preference over ordinary shareholders.
*)%),T:!)"+'
or large publicity traded firms, debentures are viable alternative to term loans. 4kin to
promissory notes, debentures are instruments for raising long'term debt. *ebentures holders
are the creditors of the company. The obligation of the company towards its debenture holder
is similar to that of borrower who promises to pay interest and principal at specified times.
T)!/ @O4,"+'
Term loans for more than a year maturity. It is generally available for a period of B?
years. Interest on term loans is ta$ deductible. They are obtained from banks and specially
created financial institutions like ICI, ICICI and I*%I etc the purpose of term lands is mostly
to finance the company<s capital e$penditure. They are generally obtained of financing large
e$pansion, moderni1ation or diversification projects. #ence this method of financing is also
called project financing. This is the most widely used source of financing.

CAPITAL BUDGETING
CAPITAL BUDGETING
%usiness firms have scarce resources that must be allocated among competitive uses. The
financial management provides a framework for firms to take these decisions widely.
The investments decision includes not only those that create revenues and profits but also
those that reduce cost. "o, the investments decisions and the decisions relating to assets
composition of the firm.
4 capital e$penditure, from the accounting point of view, is an e$penditure that
is shown as an asset on the balance sheet. This asset, e$pect in the case of a one'depreciable
asset like land , is depreciated over its life in accounting the classification of an e$penditure as
capital or revenue e$penditure is governed by a certain conventions, by some provisions of
law, and by the management<s desire to enhance and depress reported profits. Often, outlays
on !8*, major advertising campaign, and reconditioning of plant and machinery may be
treated as revenue e$penditure for accounting purposes, been though they are e$pected to
generate a stream of benefits in future and therefore, quality or being capital e$penditure.
CAPITAL BUDGETING HA) THREE DI)TINCTI1E EATURE):$
They have long'term consequences
They often involve substantial outlay.
They may be difficult or e$pensive.
EATURE):$
It involves e$change of current funds for the benefits to be achieved in future.
uture benefits are e$pected to be reali1ed over a series of years.
There is relatively high degree of risk.
They are invariable decisions.
They have long'term and significant effect on profitability of the concern.
CAPITAL BUDGETING
I-PORTANCE
Capital budgeting is of a paramount importance in financial decision'making.
Capital budgeting decision affects the profitability of the firm. They also have a bearing
on the competitive position of the enterprise. Capital budgeting decisions determine the
future destiny of the company.
4n opportunity investment decision can yield spectacular returns where as an
ill'advised and incorrect investment decision can endanger the very survival
even of the large si1ed firms.
4 capital e$penditure decisions has its effect over a long'term time span and
inevitably affects the company<s future cost structure.
Capital investment decisions are not easily reversible, without much financial
loss to the firm.
Capital investment involves cost and the majority of the firms have scares
capital resources
Capital investment decisions are of national importance because of it
determines employment, economic activities and economic growth.
This underlines the need for thoughtful, wise and correct investment decisions
CAPITAL BUDGETING
NEED OR CAPITAL BUDGETING:$
Capital budgeting decisions are vital to an organi1ation as they include the decisions as to.
3hether or not funds should be invested in long'term projects such as setting of
an industry, purchase of plant and machinery etc.
To analyse the proposal for e$pansion or creating additional capacities.
To decide the replacement of permanent asset such as building and equipments.
To make financial analysis of various proposals regarding capital investment so as
to choose the best out of many alternative proposals.
DIICULTIE):
Capital budgeting are not easy to take there are no of factors responsible for this
The benefits from investments are received in some future period. The future is
uncertain. Therefore, an element of risk is involved. 4 failure to forecast correctly
will lead to serious errors, which can be corrected lonely at a considerable
e$penses
-roblems are also arising because cost incurred and benefits received from capital
%udgeting decisions occur at different time period. They are not logically
comparable because of the time value of money.
It is not often possible to calculate in strictly quantitative term, all the benefits of
the cost relating to a particular investment decision.
CAPITAL BUDGETING
RATIONALE+'
The rationale underlying the capital budgeting decisions is efficiently. Thus a firm
must replace wrong and obsolete plant and machinery, acquire fi$ed assets for current or
new products and make straight investment decisions. This will enable the firm to achieve
the objectives of ma$imi1ing the profits. The quality of these decisions is improved by
capital budgeting.
Capital budgeting decisions can be of two types+
B( Those which e$pand revenues
C( Those which reduces costs
IN1E)T-ENT DECI)ION) EECTING RE1ENUE:
Investment decisions are e$pected to bring in additional revenue there by raising the
si1e of firms total revenue. They can be the result of either e$pansion of present
operations of the development of new product line these decisions involved acquisition of
new fi$ed assets.
IN1E)T-ENT DECI)ION) REDUCCUIND CO)T:$
These decisions add the total revenue of the firm. These investment decisions are
subject to less uncertainty. This is because the firm has a better DfeelE for potential cost
saving as it can e$amine past production and cost data.
CAPITAL BUDGETING
THERE ARE THREE T/PE) O CAPITAL BUDGETING
DECI)ION):
1) Accept$re+ect deci"i!n"+
This is a fundamental decision capital budgeting. If the project is
accepted, ' the firm invests in it. If the proposal is rejected, the firm does not
invest in it so, by applying this criterion, all independent projects are accepted.
Independent projects are projects that do not compete with one another in such a
way the acceptance a project preclude the possibility of acceptance of another.
2) -utuall* e%clu"i,e pr!+ect" deci"i!n+
These are projects, which, compete with other projects in such a way that
the acceptance of one will e$clude the acceptance of other projects. The
alternatives are mutually e$clusive and only one may be chosen. /utually
e$clusive investment decisions acquired significance when more than one
proposal is acceptable under accept'reject criterion.
3) Capital rati!ning deci"i!n"+
Capital rationing refers to situation in which the firm has more
acceptable investments requiring greater amount of finance then is available
with the firm. It is concerned with selection of group of investment proposals
actable under accept'reject criterion under financial constraints.
E1ALUATION O IN1E)T-ENT PROPO)L):
4t each point of time a business firm has a number of proposals regarding various
number of projects in which it can invest funds. %ut funds available with the firms are
always limited and it<s not possible to invest in the entire proposal at a time
In selecting the criterion, the following two fundamental principles must be kept into
view.
CAPITAL BUDGETING
The bigger, the better principles+ the principle means that other things being equal
bigger benefits are preferable to small ones.
The bird in hand principles+ this principle means that other things being equal,
early benefits as other things are seldom equal.
%other the above principles have to be applied to take the right decision
TECHNI7UE) O CAPITAL BUDGETING
The methods of appraising capital e$penditure proposals can be classified in to two
broad categories+
B. Traditional or undiscounted cash flow techniques
C. *iscounted or time adjusted cash flow techniques
DI)COUNTED CA)H LO2 -ETHOD)
The distinguishing characteristics of discounted cash flow capital budgeting techniques
are that they taking in to consideration the time value of money while evaluating the cost
and benefits of the project. They also take into consideration the benefits and cost
occurring during an entire life of the project.
NET PRE)ENT 1ALUE -ETHOD 8NP15
,-. may be defined as the summation of the present values of the cash proceeds in
each year minus the summation of the present values of the net cash outflows in each
year.
The net present value &,-.( of a project is the sum of the present values of all the
cash'flows positive as well as negative that are e$pected to occur over the life of the
projects.
The generally formula of ,-. is+'
n
CAPITAL BUDGETING
,-. of project F '''''''' Initial investment
Ct
TFB&BGrt(
t
3here Ct F Cash flow at the end of year t
!T F *iscounted rate for year t
The steps to be followed for adopting the ,-. methods+
B( *etermine an appropriate rate of the interest that should be selected as a
minimum required rate of return. This rate should be the minimum rate of return
below which the investor considers that does pay him the invested amount.
C( Compute the present value of total investment outlay7 if the total investment is
to be made in the initial year, the present value shall be the same the cost of
investment.
H( Compute the present value of total investment proceeds i.e. cash inflows at the
above determined discounted rate
I( Calculate the ,-. of each project by subtracting the present value of cash out
flow for each project.
The present value of rupee B due in any number of years can be found by using the
following formula.

B
-. F '''''
&BGr(
t
3here -. F -resent value
r F rate of interest
t F number of years
CAPITAL BUDGETING
4CC)-T O! !)A)CT C!IT)!IO,+
I# NP1 9:ERO; ACCEPT
I# NP1< :ERO; RE0ECT
In case of mutually, e$clusive projects, the various proposals would be ranked in order to
descending order. The proposal with higher ,-. is to be accepted.
/)!IT"+'
B( It recogni1es the time value of money.
C( It is sound method of appraisal as it considers the total benefits arising out of the
proposal over its lifetime.
H( Changing discount rate can be built in to the ,-. calculation by altering the
denominators. This rate normally changes because longer the time span, lower the
value of money and higher, the discount rate
I( This method is very useful for selection of normally e$clusive projects.
DE-ERIT):
4. It is difficult to calculate to understand
%. The present value method involves the calculation of required rate of return to
discount the cash flows, which present serious problems.
C. It is an absolute measure.
*. This method may not give satisfactory results in case of projects having different
effective lives.
INTERNAL RATE O RETURN 8IRR5:
The internal rate of return &I!!( of a project is the discount rate, which makes its
,-. equal to D?E.-ut differently, it is the discount rate, which equates the present value
of future cash flows with the initial investment. It is the value or r in the following
equation+
Investment F n
CAPITAL BUDGETING
T F Ct
'''''''
B&iGr(
3here,
Ct F Cash flow at the end of the year
r F internal rate of return &I!!(
t F life of the project
4pplying following stapes can calculate I!!
)tep 4
Calculate cash flow after ta$
)tep 6
Calculation fake payback period
a.e PBP = Initial in,e"tment
$$$$$$$$$$$$$$$$$$$$$$$$
A,erage ca"& #l!'
)tep >
@ook for the factor in the present value annuity table in the year column until you arrive
at figure until you closest to the fake PBP
)tep ?
,ote the corresponding percentage.
)tep @
Calculate ,-. at that percentage
CAPITAL BUDGETING
)tep A
If ,-. is positive take a rage higher and if ,-. is negative take regret lower and once
again calculate ,-.
)tep B
Continue "tepJ until we arrive at low rates one giving positive ,-. and another giving
negative ,-..
)TEP)
4ctual I!! can be calculated by using the following formula+
LR C P(1 !# ca"& in#l!'" at LR$P(1 ca"& !ut#l!'"
IRR = $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ 8HR$LR5
P(1 !# ca"& in#l!'" at LR$P(1 !# ca"& in#l!'" at HR(
3here,
! F interest rate,
@! F lower rate
#! F #igher rate
ACCEPT OR RE0ECTION CRITERION+'
4CC)-T+ If the I!! is greater than the cost of capital.
!)A)CT+ If the I!! is less than the cost of capital.
/)!IT"+
It recogni1es the time value of money.
It considers all cash flows occurring over the entire life of the projects to
calculate its return.
It is consistent with the shareholders wealth ma$imi1ation objective.
CAPITAL BUDGETING
DE-ERIT):
It gives misleading and inconsistent results when the ,-. of a project
does not decline with discount rates.
It also fails to indicate a correct choice between mutually e$clusive
projects under certain situations.
PROITABILIT/ INDED -ETHOD 8PI5
It is ratio of the present value of the cash inflows at the required rate of return to the
initial cash outflow of the investment. :sing the profitability inde$ -I or benefits cost
ratio &%C!( a project will qualify often acceptance if its -I e$ceeds one. The ,-. will be
positive greater than one and will negative when the -I is less than one. Thus, ,-.8 -I
approaches give the same results regarding the investment proposal. The selection of
project with the -I method can also be done on the basis of ranging. -I depends upon cash
inflows before depreciation and after ta$. It makes into consideration the scrap value.
The pr!#itabilit* inde%, or -I, method compares the present value of future cash inflows
with the initial investment on a relative basis. Therefore, the -I is the ratio of the present
value of cash flows &-.C( to the initial investment of the project.
investment Initial
PVCF
PI =
In this method, a project with a -I greater than B is accepted, but a project is rejected
when its -I is less than B. ,ote that the -I method is closely related to the ,-. approach.
In fact, if the net present value of a project is positive, the -I will be greater than B. On
the other hand, if the net present value is negative, the project will have a -I of less than
B. The same conclusion is reached, therefore, whether the net present value or the -I is
used. In other words, if the present value of cash flows e$ceeds the initial investment,
there is a positive net present value and a -I greater than B, indicating that the project is
acceptable.
CAPITAL BUDGETING
-I is also known as a benefit2cash ratio.
4ccept project if -I K B.
!eject if -I L B
The formula to calculate -I or %C! is as follows+
T!tal pre"ent ,alue !# ca"& in#l!'"
PI = $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
T!tal pre"ent ,alue !# ca"& !ut#l!'"
-ERIT):
It gives due consideration to the time value of money.
"ince the present value of cash inflows is divided by initial cash outflows it is a
relative measure of the projects profitability.
DE-ERIT):
It is difficult to understand
It involves more computation than traditional methods.
T!4*ITIO,4@ O! ,O,'*I"CO:,T)* T)C#,IM:)"+
4( PA/ BAC3 PERIOD -ETHOD 8PBP5:
-ay back measures the number of years required by the cash flows after ta$ to pay back
the original outlay required in an investment proposal. It depends upon cash inflows
before depreciation and after ta$. -ayback period does not consider the scrap value. There
are two ways of calculating the -%-.
The first method can be applied when the cash inflows are uniform.
Original in,e"tment
PBP = $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
C!n"tant Annual Ca"& In#l!'"
CAPITAL BUDGETING
The annual cash flow represents the earnings i.e. estimated cash savings resulting
from the proposed investment.
If the calculated -%- is less than the standard, project is accepted and vice versa
The second method is used when projects cash flows are not equal and vary from year
to year. -ayback period is calculated.
6( DI)COUNTED PA/ BAC3 -ETHOD:
This is developed due to the limitation of the -%- method that it ignores time value
of money. #ence, an improvement is made where the present values of all inflows are
cumulated in order of time. The time at which the cumulated present value of cash
inflows equals the present value of cash outflows is known as discounted -%-. The
project, which gives a shorter discounted payback period, is accepted.
REA)ON) OR POPUIARIT/ O PEP:
*espite its serious short comings the -%- is widely used in appraising
investments.
The -%- /ay be regarded roughly as the reciprocal for the I!! when the annual
cash inflow is constant and the life of the project fairly long.
The -%- is somewhat akin to the breakeven point. 4 rule of thumb, it serves as a
useful shortcut in the process of informational of generation and evaluation
The -%- conveys information about the rate at which the uncertainty associated
with a project is resolved. The shorter the -%- the faster the uncertainty associated
with the project is resolved and vice versa
ACCEPT OR RE0ECT CRITERION:
The payback period method can be used as a decision criterion to accept or reject
investment proposals. If a single investment is being considered, if the annual pay back
period is less than the predetermined payback period the project will be accepted, if not it
would be rejected.
CAPITAL BUDGETING
3hen the mutually e$clusive projects consideration they may be ranked according
to the length of the payback period. The project with shortest pay back may be assigned.
/)!IT"+
It is the best method incase o evaluation of single project.
It is to calculate and simple to understand.
It is bases on the cash flow analysis.
*)/)!IT"+
It completely ignores all cash flows after the payback period.
It completely ignores time value of money.
In case the cash flow is unequal the payback period can be found by adding up the cash
flows until the total is equal to the initial cash outlay of the project.
>( ACCOUNTING RATE O RETURN 8ARR5:
4verage rate or return is also known as accounting rate or return method. It is based on
accounting information rather than cash flows. 4!! is a technique that helps us in
knowing the particular project, from which decision can be made to accept or reject the
investment proposal.
4ccording to 4!! as an accept 2 reject criterion, the actual 4!! would compared with
the predetermined or a minimum required rate of return or cut off rate. 4 project can be
accepted if the actual 4!! is higher than the minimum desired 4!!, otherwise it is liable
to reject
4!! depends upon profit after depreciation and ta$ &-4T(, 4!! neglects the scrap
value. The time value of money is not taken into consideration.
A,erage annual pr!#it a#ter ta%
ARR = $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$ E4FF
A,erage in,e"tment
A,erage In,e"tment = Net Additi!nal '!r.ing capital C )al,age ,alue C
CAPITAL BUDGETING
4G68Original In,e"tment$)al,age ,alue5(
T!tal ca"& #l!' a#ter ta%
A,erage Annual pr!#it a#ter ta% = $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
Li#e !# t&e pr!+ect
ACCEPT OR RE0ECT CRITERION:
The actual average rate or return is compared with pre'determined or minimum
required rate of return or cut off rate. 4 project would qualify to be accepted, if the actual
rate of return is higher than the minimum desired average of return.
It more than one alternative proposal are under consideration, the average rate of return
may be arranged in descending order of magnitude starting with the proposal with the
highest average rate of return.
-ERIT):
It is simple to understand and easy to calculate,
The entire stream of incomes is used to calculate the average rate of return.
C!mpari"!n bet'een i,e Tec&niHue" in Capital Budgeting
4*.4,T4=)" 4,* *I"4*.4,T4=)" O I!! 4,* ,-.
4 number of surveys have shown that, in practice, the I!! method is more popular
than the ,-. approach. The reason may be that the I!! is straightforward, but it uses
cash flows and recogni1es the time value of money, like the ,-.. In other words, while
the I!! method is easy and understandable, it does not have the drawbacks of the 4!!
and the payback period, both of which ignore the time value of money.
CAPITAL BUDGETING
The main problem with the I!! method is that it often gives unrealistic rates of
return. "uppose the cutoff rate is BBN and the I!! is calculated as I?N. *oes this mean
that the management should immediately accept the project because its I!! is I?N. The
answer is noO 4n I!! of I?N assumes that a firm has the opportunity to reinvest future
cash flows at I?N. If past e$perience and the economy indicate that I?N is an unrealistic
rate for future reinvestments, an I!! of I?N is suspect. "imply speaking, an I!! of I?N
is too good to be trueO "o unless the calculated I!! is a reasonable rate for reinvestment
of future cash flows, it should not be used as a yardstick to accept or reject a project.
4nother problem with the I!! method is that it may give different rates of return.
"uppose there are two discount rates &two I!!s( that make the present value equal to the
initial investment. In this case, which rate should be used for comparison with the cutoff
rate; The purpose of this question is not to resolve the cases where there are different
I!!s. The purpose is to let you know that the I!! method, despite its popularity in the
business world, entails more problems than a practitioner may think.
C. 2H/ THE NP1 AND IRR )O-ETI-E) )ELECT DIERENT PRO0ECT):
3hen comparing two projects, the use of the ,-. and the I!! methods may give
different results. 4 project selected according to the ,-. may be rejected if the I!!
method is used.
"uppose there are two alternative projects, P and Q. The initial investment in each
project is >C,J??. -roject P will provide annual cash flows of >J?? for the ne$t B? years.
-roject Q has annual cash flows of >B??, >C??, >H??, >I??, >J??, >R??, >S??, >T??,
>U??, and >B,??? in the same period. :sing the trial and error method e$plained before,
you find that the I!! of -roject P is BSN and the I!! of -roject Q is around BHN. If you
use the I!!, -roject P should be preferred because its I!! is IN more than the I!! of
-roject Q. %ut what happens to your decision if the ,-. method is used; The answer is
that the decision will change depending on the discount rate you use. or instance, at a
JN discount rate, -roject Q has a higher ,-. than P does. %ut at a discount rate of TN,
-roject P is preferred because of a higher ,-..
CAPITAL BUDGETING
The purpose of this numerical e$ample is to illustrate an important distinction+ The
use of the I!! always leads to the selection of the same project, whereas project selection
using the ,-. method depends on the discount rate chosen.
PRO0ECT )I:E AND LIE
There are reasons why the ,-. and the I!! are sometimes in conflict+ the si1e and
life of the project being studied are the most common ones. 4 B?'year project with an
initial investment of >B??,??? can hardly be compared with a small H'year project costing
>B?,???. 4ctually, the large project could be thought of as ten small projects. "o if you
insist on using the I!! and the ,-. methods to compare a big, long'term project with a
small, short'term project, don<t be surprised if you get different selection results. &"ee the
equivalent annual annuity discussed later for a good way to compare projects with
unequal lives.(
DIERENT CA)H LO2)
urthermore, even two projects of the same length may have different patterns of
cash flow. The cash flow of one project may continuously increase over time, while the
cash flows of the other project may increase, decrease, stop, or become negative. These
two projects have completely different forms of cash flow, and if the discount rate is
changed when using the ,-. approach, the result will probably be different orders of
ranking. or e$ample, at B?N the ,-. of -roject 4 may be higher than that of -roject %.
4s soon as you change the discount rate to BJN, -roject % may be more attractive.
2HEN ARE THE NP1 AND IRR RELIABLEI
=enerally speaking, you can use and rely on both the ,-. and the I!! if two
conditions are met. irst, if projects are compared using the ,-., a discount rate that
fairly reflects the risk of each project should be chosen. There is no problem if two
projects are discounted at two different rates because one project is riskier than the other.
!emember that the result of the ,-. is as reliable as the discount rate that is chosen. If
the discount rate is unrealistic, the decision to accept or reject the project is baseless and
unreliable. "econd, if the I!! method is used, the project must not be accepted only
because its I!! is very high. /anagement must ask whether such an impressive I!! is
possible to maintain. In other words, management should look into past records, and
CAPITAL BUDGETING
e$isting and future business, to see whether an opportunity to reinvest cash flows at such
a high I!! really e$ists. If the firm is convinced that such an I!! is realistic, the project
is acceptable. Otherwise, the project must be reevaluated by the ,-. method, using a
more realistic discount rate.
-!di#ied IRR 8-IRR5
The /I!! is similar to the I!!, but is theoretically superior in that it overcomes two
weaknesses of the I!!. The /I!! correctly assumes reinvestment at the project<s cost of
capital and avoids the problem of multiple I!!s. #owever, please note that the /I!! is
not used as widely as the I!! in practice.
There are H basic steps of the /I!!+
)stimate all cash flows as in I!!.
Calculate the future value of all cash inflows at the last year of the project<s life.
*etermine the discount rate that causes the future value of all cash inflows
determined in step C, to be equal to the firm<s investment at time 1ero. This
discount rate is know as the /I!!.
/I!! is better than I!! because
/I!! correctly assumes reinvestment at project<s cost of capital.
/I!! avoids the problem of multiple I!!
E7UI1ALENT ANNUAL ANNUIT/
3hat do you do when project lives vary significantly; 4n easy and intuitively
appealing approach is to compare the Dequivalent annual annuityE among all the projects.
The equivalent annuity is the level annual payment across a project<s specific life that has
a present value equal to that of another cash'flow stream. -rojects of equal si1e but
different life can be ranked directly by their equivalent annuity. This approach is also
known as equivalent annual cost, equivalent annual cash flow, or simply equivalent
annuity approach. The equivalent annual annuity is solved for by this equation+
)quivalent 4nnuity F -. &Cash lows( 2 &present value factor of n'year annuity(
CAPITAL BUDGETING
PRO0ECT DECI)ION ANAL/)I)
-A3ING GOGNO$GO PRO0ECT DECI)ION
.irtually all general managers face capital'budgeting decisions in the
course of their careers. The most common of these is the simple DyesE versus
DnoE choice about a capital investment. The following are some general
guidelines to orient the decision maker in these situations.
ocus on cash flows, not profits. One wants to get as close as possible to the
economic reality of the project. 4ccounting profits contain many kinds of
economic fiction. lows of cash, on the other hand, are economic facts.
ocus on incremental cash flows. The point of the whole analytical e$ercise is to
judge whether the firm will be better off or worse off if it undertakes the project.
Thus one wants to focus on the changes in
cash flows effected by the project. The analysis may require some careful
thought+ a project decision identified as a simple go2no'go question may hide a
subtle substitution or choice among alternatives. or instance, a proposal to invest
in an automated machine should trigger many questions+ 3ill the machine e$pand
capacity &and thus permit us to e$ploit demand beyond our current limits(; 3ill
the machine reduce costs &at the current level of demand( and thus permit us to
operate more efficiently than before we had the machine; 3ill the machine create
other benefits &e.g., higher quality, more operational fle$ibility(; The key
economic question asked of project proposals should be, D#ow will things change
&i.e., be better or worse( if we undertake the project;E
4ccount for time. Time is money. 3e prefer to receive cash sooner rather than
later. :se ,-. as the technique to summari1e the quantitative attractiveness of
the project. Muite simply, ,-. can be interpreted as the amount by which the
market value of the firm<s equity will change as a result of undertaking the
project.
4ccount for risk. ,ot all projects present the same level or risk. One wants to be
compensated with a higher return for taking more risk. The way to control for
variations in risk from project to project is to use a discount rate to value a flow of
cash that is consistent with the risk of that flow.
CAPITAL BUDGETING
These I precepts summari1e a great amount of economic theory that has stood
the test of time. Organi1ations using these precepts make better investment decisions
than organi1ations that do not use these precepts.
THE PROCE)) O PRO0ECT E1ALUATION
Carefully estimate e$pected future cash flows.
"elect a discount rate consistent with the risk of those future cash flows.
Compute a Dbase'caseE ,-..
Identify risks and uncertainties. !un a sensitivity analysis.
Identify Dkey value driversE.
Identify break'even assumptions.
)stimate scenario values.
%ound the range of value.
Identi#* Hualitati,e i""ue"(
le$ibility
Muality
Vnow'how
@earning
Decide
CAPITAL BUDGETING
A(CAPITAL RATIONING
)$ists whenever enterprises cannot, or choose not to, accept all value'creating
investment projects. -ossible causes+
%anks and investors say D,OE
/anagerial conservatism
4nalysis is required. One must consider sets of projects, or DbundlesE, rather than
individual projects. The goal should be to identify the value'ma$imi1ing bundle of
projects.
The danger is that the capital'rationing constraint heightens the influence of
nonfinancial considerations, such as the following+
Competition among alternative strategies
Corporate politics
%argaining games and psychology
The outcome could be a sub'optimal capital budget, or, worse, one that destroys
valueO
"ome remedies are the following+
!ela$ and eliminate the budget constraint.
/anage the process rather than the outcomes.
*evelop a corporate culture committed to value creation.
CAPITAL BUDGETING
-ERGER A) A CAPITAL BUDGET+
:nder this method the merger decision should be considered as project investment
decision, the ,-. mergers should be determined by comparing the present values of the
acquisition firm after merger.
,-. F &-. of merger firm P holding value of acquiring firms( ' &-. of acquiring firm(,
RI)3 AND UNCERTAINIT/ IN CAPITAL BUDGETING+'
4ll the techniques of capital budgeting requires the estimation of future cash
inflow and cash outflows. The cash flows are estimated abased on the following factors.
)$pected economic life of the project.
"alvage value of the asset at the end of the economic life.
Capacity of the product.
"elling price of the product.
-roduction cost.
*epreciation.
!ate of Ta$ation
uture demand of the product, etc.
%ut due to uncertainties about the future the estimates of demand, production, sales
costs, selling price, etc cannot be e$act, for e$ample a product may become obsolete
much earlier than anticipated due to un e$pected technological developments all these
elements of uncertainties have to be take into account in the form of forcible risk while
making an investment decision. %ut some allowances for the element of risk have to be
proved.
CAPITAL BUDGETING
ACTOR) INLUENCING CAPITAL EDPENDITURE DE)CI)ION):
There are many factors financial as well as non financial which influence the capital
e$penditure decisions and the profitability of the proposal yet, there are many other
factors which have to be taken into consideration while taking a capital e$penditure
decisions. They are
45 URGENC/:
"ometime an investment is to be made due to urgency for the survival of the firm
or to avoid heavy losses. In such circumstances, proper evaluation cannot make though
profitability tests. )$amples of each urgency are breakdown of some plant and machinery
fire accidents etc.
65 DEGREE O UNCERTAINT/:
-rofitability is directly related to risk, higher the profits, greater is the risk or
uncertainty.
>5 INTANGIBLE ACTOR):
"ometimes, a capital e$penditure has to be made due to certain emotional and
intangible factors such as safety and welfare of the workers, prestigious projects, social
welfare, goodwill of the firm etc.
?5 A1AILABILIT/ O UND):
4s the capital e$penditure generally requires the previsions of laws solely
influence by this factor and although the project may not be profitable. Qet the investment
has to be made.
@5 UTURE EARNING):
4 project may not be profitable as competed to another today, but it may be
profited to increase future earnings.
CAPITAL BUDGETING
"ometimes project with some lower profitability may be selected due to constant
flow of income as compared to another project with an irregular and uncertain inflow of
income..
CAPITAL EDPENDITURE CONTROL:
Capital e$penditure involves no'fle$ible long'term commitments of funds. The
success of an enterprise in the long run depends up on the effectiveness with which the
management makes capital e$penditure decision. Capital e$penditure decisions are very
important as their impact is more or less permanent on the well being and economic
health of the enterprise. %ecause of this large scale mechani1ation and automation and
importance of capital e$penditure for increase in the profitability of a concern. It has
become essential to maintain an effective system of capital e$penditure control.
OB0ECTI1E) CONTROL O CAPITAL EDPENDITURE+
To make an estimate of capital e$penditure and to see that the total cash outlay is
within the financial resources of the enterprise
To ensure timely cash inflows for the projects so that no availability of cash may
not be problem in the implementation of the problem.
To ensure that all capital e$penditure is properly sanctioned.
To properly coordinates the projects of various departments
To fi$ priorities among various projects and ensure their follow'up.
To compare periodically actual e$penditure with the budgeted ones so as to avoid
any e$cess e$penditure.
To measure the performance of the project.
To ensure that sufficient amount of capital e$penditure is incurred to keep pace
with rapid technological development.
CAPITAL BUDGETING
To prevent over e$pansion.
)TEP) IN1OL1ED IN CONTROL O CAPITAL EDPENDITURE:
-reparation of capital e$penditure budget.
-roper authori1ation of capital e$penditure.
!ecording and control of e$penditure.
)valuation of performance.
LEA)E INANCING:$
@ease finance is an agreement for the use of an asset for a specified rental. The owner of
the asset is called the lesser and the user the lesser
B( Operating leases
C( inancial leases
Operating leases are short'term no'cancel able leases where the risk of
obsolescence in borne by the lesser
inancial leases are long'term non'cancelable leases where any risk in the use of
asset is borne by the lessee and he enjoys the return too.
-reliminary budget estimates for the year following the budget year.
GENERAL GUIDELINE):$
The capital funds budget is to be prepared under si$ major heads.
B( Continuing schemes
C( ,ew schemes
CAPITAL BUDGETING
H( /oderni1ation and rationali1ation
I( Township
J( "cience and technology
R( )*- schemes
"CI),C) 4,* T)C#,O@O=Q
CONTINUING )CHE-E):$
These schemes include all such schemes which are under implementation of
which funds prevision has been made in the current year 2prevision is required in the
budget year.
NE2 )CHE-E):$
This scheme includes all such schemes, which are proposed to be initiated in the
budget year and for which under provisions is required in the budget year. ,ormally, such
schemes are included in the five'year plan of the company approved by the planning
commission.
-ODERNI:ATION AND RATIONALI:ATION 8-JR5:$
This includes item of plant and machinery etc for which funds required in the
budget year and the following year. 4ll item included in /8! should result in cost
reduction2quality improvement2rebottle necking2replacement2productivity, improvement
and welfare. The /8! items are to be submitted in the following main characteristics
accompanied with full justification on the agenda of facilities increased output and
production, quality requirements bottlenecks.
!eplacement2moderni1ation.
%alancing facilities &essentially to increase production(.
Operational requirements including material handling
Muality2testing facilities.
3elfare
CAPITAL BUDGETING
/inor works.
These requirements should be protested term wise. 4 separate proposal is required for
/8! items costing more than !s B?, ??,???.
TO2N)HIP+'
Township budget is divided into two parts.
Continuing township schemes
,ew townships schemes.
unds required under each schemes should be backed up with full data on number
on quarter2scope of work to be completed against the funds requirements phasing of
budgeted funds for current year, budget year and following year etc, should be given
similar information on number of quarter2scope of work already completed, e$penditure
incurred till last year, satisfaction level it is to be added in the above back up information
for each scheme.
)CIENCE AND TECHNOLOG/:$
This budget can be divided into two categories
Continuing schemes.
,ew schemes to be taken up in the budget year.
The schemes should fall in any of the above cartages giving details on physical and
financial progress etc.
EDP )CHE-E):$
4ll funds requirements for computer are information system should be grouped
under )*- schemes and projects accordingly.
BU/ING OR PROCURING:
CAPITAL BUDGETING
%uying or procurement involves purchasing an asset permanently in the form of cash or
credit.
LEA)ING 1
)
BU/ING:
@easing equipment has the ta$ advantage of depreciation, which can mutually
benefit the lesser and lessee, other advantage of leasing, include convenience and
fle$ibility as well as speciali1ed services to the lessee. @ease privies handy to those
linens, which cannot obtain loan capital form normal sources.
The pros and cons of leasing and buying are to be e$amined thoroughly before
deciding the method of procurement i.e. leasing or buying.
CAPITAL BUDGETING
CHAPTER K III
INDU)TR/ PROILE
CO-PAN/ PROILE
CAPITAL BUDGETING
-ACHINE TOOL) INDU)TR/ K AN O1ER1IE2
India ranks nineteenth in production and si$teenth in consumption of machine
tools in the world. The Indian machine tool industry averaged more than HJ percent
growth in C??I'?J. Imports e$ceeded production in the year C??I with us>HJR million
worth machine tools being imported while the production was only us>CCJ million.
/achine tools from percent of Indies engineering industry and contributes ?.H -ercent of
total machinery e$ports.
The Indian machine tool industry currently consists about IJ? manufacturing units
of which appro$imately HH percent &BJ? units( all under the organi1ed category. urther
ten /ajor Indian companies constitute also most S? percent of the total production. The
government Owned #industan /achine tools @imited &#/T( alone accounts for ,early
HCN of /achine tools /anufactured in India 4ppro$imately SJN of the Indian /achine
tool producers have received the coveted. Certification while the large organi1ed players
cater to Indian<s #eavy and /edium industries, the small scale sectors meets the demand
of ancillary and other units
3orld wide the total modify locations are H,HHR. irst highest modify location
country is :nited "tates in BHHH lowest /odify location countries are %elarus, %osnia and
/er1egovina, %ulgaria, Croatia, /alta, !ussian ederation in only one /odify @ocation.
JB modify location are located in India. /odern /achine Tool in India<s leading
Industrial /aga1ine on machine tools and 4ncillary industries. -ublished in affectation
with the country<s ape$ %ody for the machine tools industry. Indian machine tool
/anufacture<s association &I//4(
3ith a healthy readership base of over C lakhs, this -remium quarterly maga1ine
is regularly referred to by the key decision makers in the machine tool, cutting and other
CAPITAL BUDGETING
manufacturing Industries that include C)Os. *irectors, senior managers, as well as
engineers and shop. loor technical personal apart from students. It serves as the bench
mark and with word it this ever growing sector of Indian industry.
In addition to manufactures, this publication also reaches out to e$porters, dealers,
distributors, !8* personnel )ducational institution, consultants, industry associations
and trade commission<s almost every entry in the industry.
/odern machine tools provide an intelligent balanced and cohesive insight into
the machine tools and ancillary industries in India in terms of the death editorial content.
It includes the latest trends and technologies highly useful technical articles and case
studies. %usiness strategies views and vision of industry leaders and one of the largest
ranges of machines tools2cuttings tools. This apart, there is e$haustive coverage of the
current national and international news, upcoming projects, tenders, events and much
more that help the readers to effectively manage their business in a facilitator and guide
for this burgeoning industry.
/odern machine tools strives to facilitate effective interaction among several
fatuities of the machine tool, cutting and user industries by enabling them in reaching out
to their prospects buyers and sellers through better trade contacts and more business
opportunities.
/achine tool industry has undergone a radical shift in its paradigm thinking, the
Indian machine tool industry is now recogni1ed as a provider of low'cost high quality
learn manufacturing solutions. The industry resiliently supports all its users to enhance
productivity as well as improve competitiveness, for the betterment of the final customer.
%eing an integral sector, growth of the machine tool industry has an immense
bearing on the entire economy, especially India<s manufacturing industry. )ven more
crucial for development of the country<s strategic segments such as defense, railways,
space and atomic energy.
CAPITAL BUDGETING
3orld over too, industriali1ed'advanced countries have created market inches on
the back of a well' developed and supportive machine tool sector.
In India as well, indigenous machine tools have the highest impact on capital
output ratios. /achine tool consumption of !s. B,??? crore truly supports the
advancement of the country<s engineering sector, output of which is estimated to be worth
over !s. B, J?,??? crore.
-anu#acturing range:
The Indian machine tool industry manufactures almost the complete range of
metal cutting and metal forming machine tools complete range of metal'cutting and
metal'forming machine tools.
Customi1ed in nature, the products from the Indian basket comprise and
conventional machine tools as well as computer numerically controlled &C,C( machines.
There are other variants offered by Indian manufactures too, including special purpose
machines, robots, robotics, handling systems and T-/ friendly machines.
)fforts within the industry, are now on to better the features of C,C machines,
and provide further value additions at lower costs, to meet specific requirements of users.
%ased on the perception of the current trends, and emerging demands, C,C segment
could be the driver of growth for the machine tool industry in India.
Current trend":
4 slowdown in the Indian economy since mid'BUUU had its fallout on prospects of
Indian machine tool manufactures. The Indian machine tool industry is besieged by lack
of adequate business opportunities that has stemmed from sluggish demand in the home
market of all user industries.
Output by domestic metal working machine tool manufacturers in C??B calendar
year declined by BI percent to !s.JBHS million marking the fourth yeast of decline since
BUUS, for the Indian machine tool industry. /uch of this fall was due to subdued
investment by all the major users segments of machine tools, e$cept the *efense industry,
primarily because of a higher capital e$penditure outlay.
CAPITAL BUDGETING
3hile decrease in domestic production was dormant in case of conventional
metalworking machine tools computer numerically conventional metalworking machine
tools, computer numerically controlled &C,C( machine tool manufacturers too suffered,
although marginally. @athes, machining centers, special purpose machines, and grinding
machines were among the machine tools that sustained much of the order inflow during
C??B.even though these segments registered decline, in comparison with the previous
corresponding year.
E%p!rt Per#!rmance:
In view of an imminent slowdown in the Indian economy, most Indian machine
tool manufactures focused on potential overseas markets for business opportunities.
"ustenance on Indian market alone did not look feasible enough.
urther, there has off late been a perceptible change in the image of the made in
India brand in overseas markets particularly true for Indian'built machine tools. )nhanced
features, competitive pricing, and marketing focus has increased demand for Indian W
made machine tools in overseas markets, particularly in )urope, :nited "tates, and )ast'
4sian regions.
4nd this is what Indian machine tool manufactures are hoping to leverage so as to
post an optimistic e$port turnover in the ne$t few years.
Indian'made machine tools are currently e$ported to over J? countries+ major
ones being :nited "tates, Italy, and %ra1il. =ermany and the /iddle )ast. @athes and
automats, presses, elector'discharge machines, and machining centers formed the bulk of
e$port orders for Indian manufactures. These machines from the Indian basket are
generally favored in overseas markets primarily due to their cost'competitiveness, as
compared to that available elsewhere compared to those available elsewhere.
CAPITAL BUDGETING
This vision of the Indian machine tool industry is now to step out and establish a
relative presence in, other potential markets. 3orld'over, market leaders have been those
who have looked to increase their market presence beyond their national frontiers
Indu"tr* )tructure
/achine tool industry in India comprises about IJ? manufactures with BJ? units
in the organi1ed sector. 4lmost S? percent of production in India is contributed by ten
major companies of this industry. 4nd over three'quarters of total machine tool
production in the country comes out of I"O certified companies. /any machine tool
manufacturers have also obtained C) marking certification, in keeping with requirements
of the )uropean markets. The industry has an installed capacity of over !s. B?,???
million and employs a workforce totaling RJ,??? skilled and unskilled personnel.
/achine tool industry in India is scatted all over the country. The hub of
manufacturing activities, however, is concentrated in places like /umbai and -une in
/aharashtra7 %atala, Aullundur and @udhiana in -unjab7 4hmadabad, %aroda, Aamnagar,
!ajkot and "urendranagar in =ujarat, Coimbatore and Chennai &/adras( in Tamilnadu+
some parts in )ast India7 and %angalore in Varnataka.
%angalore is considered as the hub for the Indian machine tool industry. The city,
for instance, house #/T machines Tools limited, a company that manufactures nearly HC
percent of the total machine tool industry<s output.
6(A U"er Indu"trie" )er,ice"
The industry<s prospects mainly depend on growth of engineering industries. The
user sectors of machine tools are the automotive, automobile and ancillaries, !ailways,
*efense, 4griculture, steel, ertili1ers, )lectrical, )lectronics, Telecommunication,
te$tile machinery, ball 8 roller bearings, industrial values, power'driven pumps, multi'
product engineering companies, earth moving machinery, compressors and consumer
CAPITAL BUDGETING
durable like washing machines, refrigerators, television sets, watches, dish'washers,
vacuum cleaners, air conditioners, etc.
CO-PAN/ PROILE
INTRODUCTION
-raga is one of the leading machine tool manufacturing units in India established
in the year BUIH, -raga<s production are well known in the field of machine tools the
company in organi1ed in four divisions via the machine tools forge foundry and C,C
division which pulsated with the activities of RUS employees turning out a wide range of
production the four divisions equipped with the modern facilities for design development
of manufacture of machine tools, are manned by qualified personnel with proven record
of technical knowledge and e$quisite craft smashup acquitted over a period of year.
-raga is proud of its diverse of machine tools the cutler8 tools venders milling
machines copy lathes thread rolling machines 8 -raga C,C machines which keep pace
with the ever changing technology in addition the company also manufactures a wide of
industrial forgings for railway automotive 8 ordnance applications.
-raga<s wriest investment has been in its e$cellent collaboration with world
famous names like Aones 8 shipman of :V for surface grinding and cutter of tool
vendors gamin of rance for milling machines scoffers of grace for thread rolling
machines =eorge finisher of "wit1erland for coping lather /itsubishi #eavy industries of
Aapan for machining centers of Vayo spiky of Aapan for C,C lather the collaboration
have culminated in -raga producing machine tools of the highest quality conforming to
international standards by virtue of their dependability prevision engineering 8 proven.
CAPITAL BUDGETING
PROILE O PRAGA
The -raga Tools is one of the oldest, machine Tools industries in India and has
entire its golden jubilee year in BUUH'UI. The company has incorporated has the joint
stock company is BUIH has a private company with objective of manufacturing,
instruments with the Technical assistance of a few C1echoslovakia )ngineers. The
company was incorporated in /any BUIH as a public limited company in private sector.
The name -!4=4 symboli1es the technical co'operation e$tended in the initial phase by
some C1echoslovakian engineers who suggested the naming of the company as -!4=4
after their capital city -!4=:) &-!4=4(.
In /arch BUUJ, the =overnment of India acquired the controlling interest in the
company by acquiring majority shares and placed the administrative control under the
ministry of commerce and industry from /ay BUUJ to *ecember BURH. The managing
agents /2" united industrial corporation limited initially managed the company.
4dministrative control of the company has been transferred from the defense minister to
the department of public enterprise under ministry of industry on the CJ
th
of 4pril BUTR.
-resently the company enjoys the status of being a subsidiary of #/T @T*. %angalore
when a paid up capital of the company was transferred in its name from the government.
The company has four manufacturing units located within the twin cities of
#yderabad at Vavadiguda at "ecunderabad it manufactures a wide range of machine
Tools, accessories and defiance items. 4 unit of forge and foundry divisions is located at
Vukatpally #yderabad where manufactures castings and forgings are.
4 C,C project was established with advance technology like numerical control
machines like automobiles C,C lathes, .,C mailing machines etc are manufactures with
the qualified personnel<s in the fields of engineering of technology.
CAPITAL BUDGETING
The company has manpower of C??? employees turning out wide range of
products.
The company has organi1ed into four divisions vi1., the machine Tools division
&/T'I(, machine Tools II &/T'II(, forge and foundry division, and the C,C division.
-erformance -raga machine tools ate penetrating large segments of foreign
markets including :V CIC Canada, %ulgaria, Indonesia, =ermany, Aapan.
-!4=4 is even more proud of the fact that it has contributed to the development
of thee machine tools industry in the development of the machine tools industry in the
country and the creation of a vast band of skilled technicians thus -raga today in name of
techno, within the machine tool industry.
CORPORATE 1I)ION O PRAGA TOOL
1I)ION )TATE-ENT:
-raga tools to be the provider of choice for total machine tools solution to
customers and a significant provider of service in Indian industry of oversees too the
strong market position in to be sustained by the provision of integrated products and
services and the aggressive marketing of machine tool knowledge e$pensive and support
services.
CO-PAN/ )TATRATEG/:
B. To maintain good customer relation
C. -roviding after seller service
H. Increasing the book order position
I. To maintain good quality and loyalty of the customers on their products
J. /aintain better research and development activities
R. !elation to company and other customer services through conducting the product
e$hibition within the company preview
7UALIT/ 1ALUE:
Commitment of the management of the quality at all stagers.
To create quality culture among all employees to maintain quality leadership in all
products.
To maintain quality leadership in all products and services.
Total customer satisfaction through quality goods and services.
CAPITAL BUDGETING
Total quality through performance leadership.
-ANUACTURING ACILITIE)
The company has two manufacturing units the order manufacturing unit is located
at Vavadiguda in "ecunderabad, the heart of the city these unit houses the machine toils
division and the corporate head office and accompanies and area of slightly over B acres
the company.
#as its second manufacturing has is at balanagar in #yderabad, about J to R
kilometers from #yderabad, airport the C,C division forge shop of foundry division are
located in the balanagar unit the total and available with the currently utili1ed by the C,C
division forge shop and foundry division leaving a surplus of nearly B?? acres.
PRODUCT RANGE:
The company has three manufacturing division vi1., can pavilion forge shop and
foundry division.
-ACHINE TOOL) DI1I)ION:
The major products manufactured by the company in its machine toll division are
cutler of fool grinders, milling machines, thread rotting machine, lather chucking etc.
There products were developed with the technical assistance of the world'renowned
machine tool manufacture by entering into collaboration agreements with /2s. )scoffier,
"4, rance, /2s. . -ratt and Co. and :.V. There machines enjoy good reputation in the
market.
ORCE DI1I)ION:
!ailway *uplication
4uto dialer pants
Tractors links
CAPITAL BUDGETING
Other carting
BOUNDAR/ DI1I)ION:
Carting #!r c!mpanie" mac&ine t!!l"+
The sophisticated machines like C,C machining center sideway, grinding
machines, universal grinding machines, jigs boring machine with coordinated system
been added at a cost of !s. B,B?S.?J lacks.
PRAGA) 1ALUE):
:nderlying our minion in a set of core corporate valued which deliver praga
priorities. This set of values creates an overall framework for determining our derived
future and developing plans to achieve it.
-raga take advantage of e$isting synergies and foreseeing higher level of
competitiveness. "afety in the priority value for all aspects of our business.
)2OT Anal*"i":
)TRENGTH):
-roven products and brand image.
#igh brand loyalty of customer.
#igh market shares in few of the products categories.
"killed work force.
I"O U??B accredited company.
2EA3NE)):
@imited product gage.
@ow volume production.
Out dead technology.
Inadequacy of working capital.
4berrance of /I".
%oard needs to be board bared and must include.
inancial e$pensive.
Obralete machinery.
CAPITAL BUDGETING
#igh man power cost.
-oor marketing plants.
OPPORTUNITIE):
-rospects of improved in auto and automotive sector.
)$port potential for e$ports of machines.
oreign and components&with up gradation(
Opportunity to from joint venture update technology. 4nd use technical manicuring
e$perience for globali1ation through venture partnership.
*iversification into related areas where ever synergy e$ists.
T&reat":
*windling market for some of the products server.
Competition from imports of latest technology machines.
4 threat from second hand machine imparts.
"hrinking resources of traditional customers, defense and railways.
The above analysis indicates ample scope and prospects for the company subject to
corrective steps being taken early.
CAPITAL BUDGETING
CHAPTER I1
DATA ANAL/)I)
J
INTERPRETATION
CAPITAL BUDGETING
PRO0ECT $4
This project B is with a capital investment is about !s. CC?.?? lakhs.
CA)H LO2 ATER TAD OR PRO0ECT$ 4
PRO0ECT K 6
This project C is with a capital investment is about !s.BR? lakhs.
Qear Mty
"ale
.alue
Total
Cost
=ross
)arnings
Total
*ep
,et
)arnings
Ta$
HBN -4T
4dd.
*ep. C4T
B C H I JFH'I R SFJ'R T UFS'T B? BBFUGB?
B T JRR.JR J?U.U JR.RR ?.TJ JJ.TB BS.H HT.JB ?.TJ HU.HR
C CJ BSS?.J BJUH.IJ BSS.?J ?.TJ BSR.C JI.RC BCB.JT ?.TJ BCC.IH
H CS BUBC.BI BSC?.UH BUB.CB ?.TJ BU?.HR JU.?B BHB.HJ ?.TJ BHC.C
TOT4@ R? CUB.II CUH.UU

CAPITAL BUDGETING
CA)H LO2 ATER TAD OR PRO0ECT K 6
Qear Mty
"ale
.alue
Total
Cost
=ross
)arnings
Total
*ep
,et
)arnings
Ta$
HBN -4T
4dd.
*ep. C4T
B C H I JFH'I R SFJ'R T UFS'T B? BBFUGB?
B J JJIR.H JHSU.UB BRR.HU CI BIC.HU II.BI UT.CJ CI BCC.CJ
C I IIHS.?I ICBJ.BU CCB.TJ CI BUS.TJ RB.HH BHR.JC CI BR?.JC
H I IIHS.?I IHC?.JS BBR.IS CI UC.IS CT.RS RH.T CI TS.T
I I IIHS.?I II?R.UT H?.?R CI R.?R B.TT I.BT CI CT.BT
TOT4@ BS H?C.SJ HUT.SJ

CAPITAL BUDGETING
Pa*bac. Peri!d
THE PA/BAC3 PERIOD O PRO0ECT$4
&!s in lakhs(
Qear 4nnual cash inflows Cumulative cash inflows
B HU.HR HU.HR
C BCC.IH BRB.SU
H BHC.C CUH.UU
.
Investment is !s CC?.?? lakhs.
-ayback period F@ower year G Original cost of product W 44CI of lower year 2
44CI of upper year W 44CI of lower year
-ayback period F C G &CC? W BRB.SU( 2 &CUH.UU W BRB.SU(
F C G &JT.CB 2 BHC.C(
FC G ?.II
F 6(? *ear"
CAPITAL BUDGETING
Interpretati!n: In this project the initial investment is !s CC?.??lakhs are recovered in
the C
nd
year of I
th
/onth
THE PA/BAC3 PERIOD O PRO0ECT$6
&!s in lakhs(
Qear 4nnual cash inflows Cumulative cash inflows
B BCC.CJ BCC.CJ
C BR?.JC CTS.SS
H TS.T HS?.JS
I CT.BT HUT.SJ
Investment is !s BR? lakhs.
-ayback period F@ower year G Original cost of product W 44CI of lower year 2
44CI of upper year W 44CI of lower year
-ayback period F BG &BR?'BCC.CJ( 2 &CTS.SS'BCC.CJ(
F 4(6*ear"(
Interpretati!n:
In this project the initial investment is !s BR?.?? lakhs are recovered in the B
st
year of C
nd
month.
CAPITAL BUDGETING
igure 4:
Acc!unting Rate !# Return
THE ARR O PRO0ECT$4
&!s in lakhs(
Qear ,-4T
B HT.JB
C BCB.R
H BHB.I
Total CUB.I
CAPITAL BUDGETING
4ccounting rate of return F average income 2 4verage investment.
4verage investment F &Original investment W "crap value(2C
4verage income F Total income 2 ,umber of years.
Investment is !sCC?.?? lakhs.
4verage investment F CC?2C
F BB?
4verage income F CUB.II2H
F US.BI
4!! F &US.BI2BB?( B??
ARR = LLM
THE ARR O PRO0ECT$6
&!s in lakhs(
Qear ,-4T
B UT.CJ
C BHR.J
H RH.T
I I.BT
Total H?C.T
CAPITAL BUDGETING
4ccounting rate of return F average income 2 4verage investment.
4verage investment F &Original investment W "crap value(2C
4verage income F Total income 2 ,umber of years.
Investment is !s.BR? lakhs.
4verage investment F BR?2C
F T?
4verage income F H?C.SJ2I
F SJ.RT
4!! F &SJ.RT2T?( B??
=N?(AM
igure 6
CAPITAL BUDGETING
Net Pre"ent 1alue
NET PRE)ENT 1ALUE O THE PRO0ECT$4
&!s in lakhs(
Qear Cash flow -...factorXB?N Cash flows of -..
B HU.HR ?.U?U HJ.SS
C BCC.IH ?.TCR B?B.BC
H BHC.C ?.SJB UU.CT
I Total CHR.BS
Total C of -. F CHR.BS
&'( Investment F CC?.??
NP1 = 4A(4B
Interpretati!n:
,-. of project'B is positive &G( i.e. !s BR.BS lakhs, so project is acceptable for
company.
CAPITAL BUDGETING
NET PRE)ENT 1ALUE O THE PRO0ECT$6
&!s in lakhs(
Qear Cash flow -...factorXB?N Cash flows of -..
B BCC.CJ ?.U?U BBB.BC
C BR?.JC ?.TCR BHC.JT
H TS.T ?.SJB RJ.UH
I CT.BT ?.RTH BU.CI
J Total HCT.TS
Total C. of -. F HCT.TS
&'( Investment F BR?.??
NP1 = 4AL(LB
Interpretati!n:
,-. of project'C is positive &G( i.e. !s BRT.TS lakhs, so project is acceptable for
company.
CAPITAL BUDGETING
igure >
Pr!#itabilit* Inde%
PROITABILIT/ INDED O PRO0ECT$4:
&!s in lakhs(
Qear Cash flow -...factorXB?N Cash flows of -..
B HU.HR ?.U?U HJ.SS
C BCC.IH ?.TCR B?B.BC
H BHC.C ?.SJB UU.CT
I Total CHR.BS
Total C of -. F CHR.BS
CAPITAL BUDGETING
&'( Investment F CC?.??
NP1 = 4A(4B
-I F -. of cash inflows 2 initial cash outlay
PI = 6>A(4BG66F= 4(FB
Interpretati!n:
The profitability inde$ value is B.?S, which is more than the value Y?<, and also the
,-. is positive hence the project is viable to company.
PROITABILIT/ INDED O PRO0ECT$6:
&!s in lakhs(
Qear Cash flow -...factorXB?N Cash flows of -..
B BCC.CJ ?.U?U BBB.BC
C BR?.JC ?.TCR BHC.JT
H TS.T ?.SJB RJ.UH
I CT.BT ?.RTH BU.CI
J Total HCT.TS
Total C. of -. F HCT.TS
&'( Investment F BR?.??
NP1 = 4AL(LB
CAPITAL BUDGETING
-I F -. of cash inflows 2 initial cash outlay
PI = >6L(LBG4AF =6(F@
Interpretati!n:
The profitability inde$ value is C.?J, which is more than the value Y?<, and also the
,-. is positive hence the project is viable to company.
igure ?

Internal Rate !# return
IRR O PRO0ECT K 4
-ay %ack -eriod F C.I years
-resent value of annuity for -%- lies between BCN and BHN
BCN ''''''''''''''''''''''''' C.I?C
BHN ''''''''''''''''''''''''' C.HRB
I!! F BH W &C.I WC.HRB( 2 &C.I?C WC.HRB(
IRR = 44(LLM
Interpretati!n:
CAPITAL BUDGETING

The minimum e$pected rate of return of company is B?N. "ince the I!! of
project'B i.e. BB.TTN is greater than e$pected rate of return, it is observed that project is
viable to company.
IRR O PRO0ECT K 6
Invest of -roject'C is !s.BR? @akhs.
,-.F ?
&Cash inflow ' Investment( F ?
The I!! is the value of Yr<, which satisfies the following equation.
BR? F BCC.CJ G BR?.JC G TS.T? G CT.BT
&BGr( &BGr( C &BGr( H &BGr( I

The calculation of <r< involves a process of trail and error. 3e try different values
of Yr< till we find that the !#" of the above equation is equal to !s.BR?@akhs. @et us, to
began with, try rFRCN. This makes the !#" equal to+
HU.HR G BCC.IH G BHC.C? F BRB.HS
&BG?.RC( &BG?.RC( C &BG?.RC( H
The value is slightly higher than our target value!s.BR?lakhs. "o we
increase the value of Yr< from RCN to RHN.
HU.HR G BCC.IH G BHC.C? F BJU.RT
&BG?.RH( &BG?.RH( C &BG?.RH( H
CAPITAL BUDGETING
"ince this value is now less than BR?, we conclude that value of Yr<lies between
RCN to RHN. rom most of the purposes this indication sufficient. If a move'refined
estimate of Yr< is needed, use the following procedure.
&B( *etermine the ,-. of Two closest rates of return.
&,-.2RCN( B.HS
&,-.2RHN( ?.HC
&C( ind sum of the absolute values of the ,-. obtained in step B+
B.HS G ?.HC F B.RU
&H( Calculate the ratio of the ,-. of the smaller discount rate identified in step B+ to the
sum obtained in stepC+
?.HC2B.RU F ?.BT
&I( 4dd the number obtained in stepH+ to the smaller discount rate+
A6CF(4L = A6(4LM
Interpretati!n:
The minimum e$pected rate of return of company is B?N. "ince the I!! of
project'C i.e. RC.BTN is greater than e$pected rate of return, it is observed that project is
viable to company.
igure@
CAPITAL BUDGETING

CHAPTER 1
INDING); CONCLU)ION
)UGGE)TION)
CAPITAL BUDGETING
INDING) G CONCLU)ION)
The study concerned with the capital budgeting with reference to company
the data is collected, organi1ed, analy1ed and interpreted.
The following findings are obtained from the analysis of data+
B The project B is with a capital investment is about !s.T.BClakhs.
The non'discounted payback period is C.I years. The investment will
recover in C year and I
th
month only.
The 4!! is TTN more than the required rate of return. Therefore,
accept the project on 4!! basis.
,-. is positive &G( i.e.!sBR.BS lakhs, so accept the project.
The profitability inde$ is B.?S times K B.
The I!! is BB.TTN more than the required rate of return.
C. The project C is with a capital investment is about !s.BR?lakhs.
The non'discounted payback period is B.C years. The investment will
recover in Byear and C month.
CAPITAL BUDGETING
The 4!! is UI.RN more than the required rate of return. Therefore,
accept the project on 4!! basis.
,-. is positive &G( i.e.!sBRT.TS lakhs, so accept the project.
The profitability inde$ is C.?J times K B.
The I!! is RC.BTN more than the required rate of return
)UGGE)TION)
The project B is having a -%- of R.Byrs, ,-., I!!7 4!! 8 -I are
indicating a positive sign. Therefore accept the project.
The project C of is having a -%- of B.Cyrs, ,-., I!!7 4!! 8 -I
are indicating a positive sign. Therefore accept the project.
CAPITAL BUDGETING
BIBLIOGRAPH/:
BOO3):
B( 4 /urthy, " =urusamy, D/anagement 4ccountingE, .ijay ,icole, C??R.
C( I / -andey, Dinancial /anagementE, U2e, .ikas publishing, C??I.
H( / Q Vhan and - V Aain, Dinancial /anagementE, Tata /c =raw'#ill,
,ew *elhi' C??H.
2EB$)ITE):
www.wikipedia.com
www.google.com
CAPITAL BUDGETING