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Capital Budgeting is the process of identifying, analyzing and selecting investment projects whose returns are expected to extend beyond one year.
Capital Budgeting involves Generating investment projects consistent with the firms strategic objectives Estimating after tax incremental operating cash flow Evaluating incremental operating cash flow Selecting projects based on value maximizing criterion Reevaluating implemented projects continually and performing postaudits for completed projects
Types of Projects
New product or expansion of existing products Replacement of equipment or building Research and Development Exploration Other9safety related or pollution control devices)
Calculating incremental CF
Initial Cash Outflow Interim incremental cash flow Terminal cash flow
Asset expansion
New asset price= Tk. 100000 Useful life= 4 years 3 year property class Installation cost= Tk. 15000 Salvage= Tk. 15000 Tax rate= 35% Depreciation basis= Tk.100000 Net operating revenue yr. 1- Tk. 34267 yr. 2- Tk. 38260 yr. 3- Tk. 57372 yr. 4- Tk. 32358
Asset Replacement
New asset price= Tk. 18000 Useful life= 4 years 3 year property class Installation cost= Tk. 2000 Salvage of new equipment= Tk. 2500 Old equip wont have any salvage Old equip remaining life = 2 yr. Old equip original life 4yrs. 3 year property class Old equip depreciation basis= Tk. 8000 Tax rate= 35% Net operating revenue Tk. 7100