CAPITAL BUDGETING PROCESS

1 IDENTIFICATION OF POTENTIAL INVESTMENTS

2 ASSEMBLING OF PROPOSED INVESTMENTS

3 DECISION MAKING

4 PREPARATION OF CAPITAL BUDGET AND APPROPRIATION

5 IMPLEMENTATION

6 PERFORMANCE REVIEW

TYPES OF CAPITAL EXPENDITURE

1 REPLACEMENT

2 EXPANSION

3 NEW PRODUCT INVESTMENTS

4 OBLIGATORY AND WELFARE INVESTMENTS

5 R&D

APPRAISAL CRITERIA
CASH FLOW FOR PROJECT X
Year 0 Year 1 Year 2
A. INITIAL FLOW
PLANT AND EQUIPMENT (100)
WORKING CAPITAL (10)
(110)
B. OPERATING FLOW
Sales 80 100
Less : Cost of Sales (Other than
Depreciation and Interest) 40 50
Less : Depreciation 20 16
Profit before tax 20 34
Income Tax 6 10
Profit after Tax 14 24
CASH GENERATED FROM OPERATIONS
(PAT +DEPN.) 34 40
C TERMINAL CASH FLOW
Net salvage value of Plant and equipment
Net Salvage value of working capital
CASH FLOW FROM CLOSE DOWN

D NET CASH FLOW (A+B+C) (110) 34 40

- 1 2
Present Value (110) 26 23
0.33 32.97%
Year 3 Year 4 Year 5

120 150 200

60 75 100
13 10 8
47 65 92
14 19 28
33 45 64

46 56 72

20
10
30

46 56 102 278
3 4 5
19 18 25 0
 APPRAISAL CRITERIA

NON-DCF DCF

PAY BACK NET PRESENT VALUE

ACCOUNTING RATE OF RETURN INTERNAL RATE OF RETURN

BENEFIT COST RATIO

NON - DCF
1 PAY BACK - LENGTH OF TIME REQUIRED TO RECOVER THE INITIAL CASH OUTLAY
2 ACCOUNTING RATE OF RETURN - PAT/BOOK VALUE OF INVESTMENT

DCF
1 NET PRESENT VALUE - SUM OF PRESENT VALUES OF ALL THE CASH FLOWS ASSOCIA
NPV represents the net benefit over and above the compensation for time and risk

2 IRR - THE DISCOUNT RATE WHICH MAKES ITS NPV EQUAL TO ZERO
L CASH OUTLAY

SH FLOWS ASSOCIATED WITH THE PROJECT

time and risk
PROJECT REPORT

1 EXECUTIVE SUMMARY

2 BACKGROUND

3 PRODUCT AND SERVICE OFFERING

4 MARKET - TARGET, COMPETITION, PRICING

5 TECHNOLOGY

6 INFRASTRUCTURE - LAND, BUILDING, MACHINERY ETC.,

7 MANPOWER, ORGANISATION STRUCTURE, KEY PERSONNEL

8 FINANCIALS

COST OF PROJECT & MEANS OF FINANCE

PROJECTED PROFITABILITY

PROJECTED BALANCE SHEET

PROJECTED CASH FLOW

EVALUATION

9 RECOMMENDATION AND APPROVALS

QUALITATIVE ASPECTS OF CAPITAL BUDGETING

1 ASSESS THE BIASES IN THE CASH FLOW ESTIMATES

INTENTIONAL OVER STATEMENT OF BENEFITS OR UNDERSTATEMENT OF COSTS

LACK OF EXPERIENCE

POPULAR OPINIONS

CAPITAL RATIONING

TOO MUCH CAUTION

INTANGIBLE BENEFITS IGNORED

2 IDENTIFY THE REAL REASONS FOR THE POSITIVE CASH FLOW

UNDERSTANDING ENTRY BARRIERS

ECONOMIES OF SCALE

PRODUCT DIFFERENTIATION

COST ADVANTAGE

MARKETING REACH

TECHNOLOGICAL EDGE

GOVERNMENT POLICY

3 UNDERSTANDING THE QUALITATIVE INFLUENCES

INTUITION, SUPERSTITION, POLITICS ETC.,

4 STRATEGY FITMENT

BUSINESS STRENGTH, INDUSTRY ATTRACTIVENESS

COST OF CAPITAL

Reqd.Rate Proportion in
Rs. of return Total capital Cost of Capital
A EQUITY 200 20% 40% 8.00%

B DEBT
SOURCE A 200 10.5% 40% 4.20%
SOURCE B 100 12.0% 20% 2.40%
500 100.0% 14.6%
A COST OF CAPITAL AND MEANS OF FINANCE

COST OF CAPITAL

ADVANCE FOR BLG ETC 10

PLANT AND MACHINERY 50

WORKING CAPITAL 120

180

MEANS OF FINANCE PROPORTION WACC

TERM LOAN 30 17% 7% 1.2%

WORKING CAPITAL LOAN 84 47% 7% 3.3%

EQUITY 66 37% 20% 7.3%

180 100% 11.8%

B PROJECTED PROFITABILITY YEAR 1 YEAR 2 YEAR 3 YEAR 4

PLANT CAPCITY 24 24 24 24

SELLING PRICE PER TON 20 20 20 20

PLANNED CAPACITY 24 24 24 24

SALES 480.00 480.00 480.00 480.00

RAW MATERIAL CONSUMPTION 316.80 316.80 316.80 316.80

SALES COMMISSION 48.00 48.00 48.00 48.00

MOULLD COST 12.00 12.00 12.00 12.00

MFG AND ADMIN 24.00 24.00 24.00 24.00

ADDITIONAL MKG EXPENSES 30.00 30.00 30.00 30.00

SALARIES &WAGES 24.00 24.00 24.00 24.00

 DEPRECIATION 10.00 8.00 6.40 5.12

464.80 462.80 461.20 459.92

PBIT 15.20 17.20 18.80 20.08

INTEREST ON TERM LOAN 3.00 2.40 1.80 1.20

INTEREST ON WORKING CAPITAL LOAN 8.40 8.40 8.40 8.40

PBT 3.80 6.40 8.60 10.48

INCOME TAX 1.14 1.92 2.58 3.14

PAT 2.66 4.48 6.02 7.34

C. DEPRECIATION CALCULATION

OPENING WDV 50.00 40.00 32.00 25.60

DEPRECIATION 10.00 8.00 6.40 5.12

CLOSING WDV 40.00 32.00 25.60 20.48

D TERM LOAN INTERREST CALCULATION

OPENING BALANCE 30.00 24.00 18.00 12.00

REPAYMENT 6.00 6.00 6.00 6.00

CLOSING BALANCE 24.00 18.00 12.00 6.00

INTEREST 3.00 2.40 1.80 1.20

E WORKING CAPITAL LOAN INTEREST

TOTAL WORKING CAPITAL 120.00 120.00 120.00 120.00

W.CAP LOAN @70% 84.00 84.00 84.00 84.00

INTEREST 8.40 8.40 8.40 8.40

F BALANCE SHEET

EQUITY 66.00 66.00 66.00 66.00

RESERVES 2.66 7.14 13.16 20.50

TERM LOAN 24.00 18.00 12.00 6.00

WORKING CAPITAL LOAN 84.00 84.00 84.00 84.00

TOTAL 176.66 175.14 175.16 176.50

FIXED ASSETS

GROSS BLOCK 60.00 60.00 60.00 60.00

DEPRECIATION 10.00 18.00 24.40 29.52

NET BLOCK 50.00 42.00 35.60 30.48

WORKING CAPITAL 120.00 120.00 120.00 120.00

SURPLUS CASH OR DEFICIT 6.66 13.14 19.56 26.02

TOTAL 176.66 175.14 175.16 176.50

G CASH FLOW

INITIAL FLOW

TOTAL CAPEX (60.00)

WORKING CAPITAL (120.00)

(180.00) - - -

OPERATING FLOW

PBIT 15.20 17.20 18.80 20.08

INCOME TAX 4.56 5.16 5.64 6.02

PAT 10.64 12.04 13.16 14.06

CASH FLOW 20.64 20.04 19.56 19.18

TERMINAL FLOW

SALVAGE VALUE

WORKING CAPITAL

TOTAL CASH FLOW (159.36) 20.04 19.56 19.18

7%
YEAR 5

24

20

24

480.00

316.80

48.00

12.00

24.00

30.00

24.00
 4.10

458.90

21.10

0.60

8.40

12.10

3.63

8.47

20.48

4.10

16.38

6.00

6.00

0.60

120.00

84.00

8.40
 66.00

28.97

84.00

178.97

60.00

33.62

26.38

120.00

32.58

178.97

21.10

6.33

14.77
 18.87

5.00

120.00

125.00

143.87
 A B

A. TOTAL INVESTMENT 500 500 500

(F.A+C.A)

B OPERATING PROFIT (PBIT) 100 100 100

INTEREST 0 30 50

PROFIT BEFORE TAX 100 70 50

INCOME TAX 30 21 15

PROFIT AFTER TAX 70 49 35

ROE 14.0% 16.3% 11.7%

ROI 20% 20%

INTEREST 15%

IT RATE 30%

AFTER TAX COST OF DEBT INTEREST(1-TAX RATE)

10.5%
 DEBT 200

EQUITY 300

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