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Capital Budgeting

Capital Budgeting. It is to decide what are the major expenditures or investments a company should make , it’s a method to judge the best investments options to create future value for the company. Stages of Capital Budgeting.

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Capital Budgeting

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  1. Capital Budgeting It is to decide what are the major expenditures or investments a company should make , it’s a method to judge the best investments options to create future value for the company.

  2. Stages of Capital Budgeting • Identify Projects :Identifying potential capital investments that agree with the organization’s strategy. • Obtain Information : Gather Information from all parts of the value chain to evaluate alternative projects. • Make Predictions : Forecast all potential cash flows attributable to alternative project • Make Decision by Choosing Among Alternatives : Determine which investment yields the greatest benefit and the least cost to the organization.

  3. Stages of Capital Budgeting • Implement the Decision, Evaluate Performance, and Learn: • Obtain funding and make the investments select in stage 4. • Track realized cash flow, compare against estimated numbers, and revise plan if necessary. Illustrate Capital Budgeting Supreme Group a manufacturer of Detergent Powder. It is one of the major producers of Detergent Power with stain remover. This allowed Supreme Group to produce one of the best detergent Powder in the market. However, a new

  4. Methods to calculate Capital Budgeting • Net Present Value {NPV} • Internal Rate of Return {IRR} • Payback • Accrual Accounting Rate of Return {AARR}

  5. Methods to calculate Capital Budgeting • The NPV & IRR both methods uses the Discounted Cash Flow {DCF}. Discounted Cash Flow {DCF} : It measures all the future value cash inflows & outflows of a project discounted back to the present period. The key feature of DCF is the time value of money, which means that a rupee received today is worth more than a rupee received at any future time. The time value of money is the opportunity cost from not having the money today. Example : 10 Rs invested today at 10% growth per year will fetch you 11 Rs at the end of 1 year, so is only Rs 10 is received after one year from now then its present value is Rs 10 / Rs 11 = 0.9091 Required Rate of Return{RRR} : both the DCF methods i.e. NPV & IRR uses RRR which is the minimum acceptable annual rate of return on an investment decided by the management.

  6. Net Present Value {NPV}

  7. Internal Rate of Return {IRR}

  8. Comparison of NPV with IRR NPV • Expresses calculations in amount • Can always be a unique number • Can be used even if RRR varies for different years IRR • Calculates in terms of percentage • Changes according to the inflows and outflows during the course of project • Cannot be applied when RRR varies for different years

  9. Payback Method It is the method which measures the time it will take to recover the net initial investment in a project. Payback period = Net Initial Investment (Uniform Cash Flows) Annual Future Cash Flows Payback period (Non Uniform Cash Flows) Payback Period = 2 years + Rs 4,00,000 x 1 year = 2.5 years Rs 8,00,000

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