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Capital Budgeting Techniques (Overview)
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Heena Malhotra
Believe in Conceptual Learning.

U
Unacademy user
kuch nhi samz rha hai basic puzzle ka link dijiye na
Siddhant Jain
a year ago
Meri Jo starting ki videos h vo dekho..
Dear Madam, why is depreciation treated as cash inflow?
mam conventional techniques of capital budgeting is a discounting techniques of capital budgeting????
Anjali Rathore
6 months ago
no, it is traditional techniques.
G
conventional technique means
G
conventional technique
Anjali Rathore
6 months ago
it means traditional technique
MAM Cash outflow 3lakh kaisha hwa
  1. Capital Budgeting Decisions By Heena Malhotra


  2. Payback Period Traditional or Non Discounting ccounting Rat of Return (ARR) Capital Budgeting Techniques Net Present Value (NPV) Profitability Index (PI) Time adjusted or Discounted Cash Flows Internal Rate of Return (IRR) Modified Internal Rate of Return (MIRR) Discounted Payback By Heena Malhotra


  3. o I. Estimation of Cash flows over the entire life o 2. Evaluate each of the alternative using o 3. Determining the minimum required rate of Steps of Capital Budgeting Procedure for each of the projects under consideration. different decision criteria. return (i.e. WACC) to be used as Discount rate. By Heena Malhotra


  4. PURPOSE OF CAPITAL BUDGETING The capital budgeting decisions are important, crucial and critical business decisions due to following reasons: () Substantial expenditure: Investment decisions are related with fulfilment of long term objectives and existence of an organization. To invest in a project or projects, a substantial capital investment is required. Based on size of capital and timing of cash flows, sources of finance are selected. Due to huge capital investments and associated costs, it is therefore necessary for an entity to make such decisions after a thorough study and planning. (i) Long time period : The capital budgeting decision has its effect over a long period of time. These decisions not only affect the future benefits and costs of the firm but also influence the rate and direction of growth of the firmRy Heena Malhotra


  5. (i) Irreversibility:Most ofthe investment decisions are irreversible.Oncethe decision implemented it is very difficult and reasonably and economically not possible to reverse the decision. The reason may be upfront payment of amount, contractua obligations, technological impossibilities etc. (v) Complex decision : The capital investment decision involves an assessment of future events, which in fact is difficult to predict. Further it is quite difficult to estimate in quantitative terms allthe benefits or the costs relating to a particular investment decision. By Heena Malhotra


  6. CAPITAL BUDGETING PROCESS Planning Fixing Priorities Screening Evaluation Implementatio Performance Review Selection By Heena Malhotra


  7. Replacement and Modernisation decisions On the basis of firm's existence Expansion decisions Diversification decisions Mutually exclusive decisions On the basis of decision situation Accept-Reject decisions Contingent decisions


  8. On the basis of firm's existence The capital budgeting decisions are taken by both newly incorporated firms as well as by existing firms. The new firms may be required to take decision in respect of selection of a plant to be installed. The existing firm may be required to take decisions to meet the requirement of new environment or to face the challenges of competition. These decisions may be classified as follows: () Replacement and Modernisation decisions: The replacement and modernisation decisions aim at to improve operating efficiency and to reduce cost. Generally, all types of plant and machinery require replacement either because of the economic life of the plant or machinery is over or because it has become technologically outdated. The former decision is known as replacement decisions and latter is known as modernisation decisions. Both replacement and modernisation decisions are called cost reduction decisions. By Heena Malhotra


  9. On the basis of firm's existence () Expansion decisions: Existing successful firms may experience growth in demand of their product line.If such fims experience shortage or delay in the delivery of their products due to inadequate production facilities, they may consider proposal to add capacity to existing product line. i)Diversification decisions: These decisions require evaluation of proposals to diversify into new product lines,new markets etc. for reducing the risk of failure by dealing in different products or by operating in several markets. Both expansion and diversification decisions are called revenue expansion decisions. By Heena Malhotra


  10. () Mutually exclusive decisions : The decisions are said to be mutually exclusive if two or more alternative proposals are such that the acceptance of one proposal will exclude the acceptance of the other alternative proposals. For instance, a firm may be considering proposal to install a semi-automatic or highly automatic machine. If the firm installs a semi-automatic machine it excludes the acceptance of proposal to install highly automatic machine. (i) Accept-reject decisions: The accept-reject decisions occur when proposals are independent and do not compete with each other. The firm may accept or reject a proposal on the basis of a minimum return on the required investment. All those proposals which give a higher return than certain desired rate of return are accepted and the rest are rejected. By Heena Malhotra


  11. ESTIMATION OF PROJECT CASH FLOWS o (a) Depreciation: Depreciation is a non-cash item and itself does not affect the cash flow. However, we must consider tax shield or benefit from depreciation in our analysis. Since this benefit reduces cash outflow for taxes it is considered as cash inflow. o (b) Opportunity Cost: alternative cash inflow foregone due to acceptance of any project should be considered as opportunity cost and should be included in our analysiS By Heena Malhotra


  12. o (d) Working Capital Every big project requires working capital because, for every business, investment in working capital is must. Therefore, while evaluating the projects initial working capital requirement should be treated as cash outflow and at the end of the project its release should be treated as cash inflow. O It is important to note that no depreciation is provided on working capital though it might be possible that at the time of its release its value might have been reduced. Further there may be also a possibility that additional working capital may be required during the life of the project. In such cases the additional working capital required is treated as cash outflow at that period of time. Similarly, any reduction in working capital shall be treated as cash inflow. o It may be noted that, if nothing has been specifically mentioned for the release of working capital it is assumed that full amount has been realized at the end of the project. However, adjustment on account of increase or decrease in working capital needs to be incorporated. By Heena Malhotra