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DECISIONS
Nature of Investment
Decisions
Features of Investment
Decisions
The
The
The
Importance of Investment
Decisions
Growth
Risk
Funding
Irreversibility
Complexity
Types of Investment
Decisions
One
classification is as follows:
Yet
Investment Evaluation
Criteria (Process of
Three steps are involved in the evaluation of an
Capital Budgeting)
investment:
1.
2.
3.
4.
5.
benefits
Stage 2- Sensitivity analysis of events occurring
Stage 3: - Discounting the future value of
benefits
Stage 4: - Comparing the costs and benefits
Stage 5: - Comparing net rate of return
Investment Decision
Rule
Evaluation Criteria
1.
2.
NPV
C3
C1
C2
Cn
C0
2
3
n
(1 k ) (1 k )
(1 k )
(1 k )
n
NPV
t 1
Ct
(1 k )
C0
Acceptance Rule
Accept
Time value
Measure of true profitability
Shareholder value
Limitations:
CALCULATION OF IRR
Uneven
Error
CALCULATION OF IRR
Rs 20,000
3.683
Rs 5,430
Acceptance Rule
Accept
Reject
May
In
PROFITABILITY INDEX
Profitability
PROFITABILITY INDEX
Acceptance Rule
The
PAYBACK
Payback
Example
Assume
PAYBACK
Acceptance Rule
The
Evaluation of Payback
Certain virtues:
Simplicity
Cost effective
Short-term effects
Risk shield
Liquidity
Serious limitations:
Cash flows after payback
Cash flows ignored
Cash flow patterns
Administrative difficulties
Inconsistent with shareholder value
2.
Accounting/ Average
RATE OF RETURN
The accounting rate of return is the ratio of the average afterMETHOD
tax profit divided by the average investment. The average
investment would be equal to half of the original investment if
it were depreciated constantly.
or
Example
A
Calculation of
Accounting Rate of
Return
Acceptance Rule
This
Evaluation of ARR
Method
The ARR
Simplicity
Accounting data
Accounting profitability
Serious
shortcomings