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CAPITAL BUDGETING

CAPITAL BUDGETING. Group Members. Adeel Akbar Taimoor Shahzada Moqeet Ahmad Muhammad Shoaib. What is Capital Budgeting?. “Capital Budgeting is the process of identifying, Analyzing and selecting investment projects whose returns (cash flows) are expected to extend beyond one year.”.

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CAPITAL BUDGETING

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  1. CAPITAL BUDGETING

  2. Group Members Adeel Akbar Taimoor Shahzada Moqeet Ahmad Muhammad Shoaib

  3. What is Capital Budgeting? “Capital Budgeting is the process of identifying, Analyzing and selecting investment projects whose returns (cash flows) are expected to extend beyond one year.”

  4. What is Capital Budgeting? “Capital Budgeting is the process of planning expenditures on assets with cash flows that are expected to extend beyond one year”

  5. Functions of Capital Budgeting

  6. Functions • Generating Investment projects proposals consistent with firm’s strategy. • Estimating after tax operating cash flows for investment projects. • Evaluating project cash flows. • Selecting a project based on Value-Maximizing criteria.

  7. Our Focused Area Selecting a project based on Value-Maximizing criteria.

  8. Techniques PBP NPV IRR PI

  9. Pay Back Period (PBP) “The Length of time required for an investment’s net Revenues to cover its cost.”

  10. Can be Calculated as: PBP= a + (b-c) d Project with Minimum PBP will be Accepted.

  11. Net Present Value (NPV) “The Present value of an investment project’s is net cash flows minus the Project’s initial cash outflow.” NPV=Present value of cash flows – Initial Investment

  12. NPV= cf1 + cf2 + …….. + cfn - ICO (1+r)1 (1+r)2 (1+r)n Where: cf = Cash flow r = Interest rate ICO= Initial Cash out flow Project with +ve NPV will be selected

  13. Internal Rate of Return (IRR) “The discount Rate that equates the present value of the future net cash flows from an investment project’s initial cash out flow.” If IRR > Given Rate, project will b accepted.

  14. Formula IRR = LDR + diff b/w NPV of LDR two rates sum of both NPVs where: LDR = Lower Discount Rate

  15. Profitability Index (PI) “The Ratio of the present value of a project’s future net cash flow to the project’s initial cash out flow”

  16. Example ABC company has two projects Project A and Project B, the maximum pay back period and interest rate for both projects is 4years and 12% respectively, cash flows of different years for both projects is given. Evaluate both projects on the basis of four capital budgeting techniques and decide which project is beneficial for the company.

  17. Cash Flows: Project A Project B Initial Investment 70,000 Initial Investment 90,000

  18. Calculation of PBP Project A a = 3 , b = 70,000 , c = 65,000 , d = 35,000

  19. Calculation of PBP Project B a = 4 , b = 90,000 , c = 81,000 , d = 20,000

  20. Pay Back Period (PBP) Project A Project B PBP = 4 + 90,000 – 81,000 20,000 = 4 + 9,000 20,000 = 4 + 0.45 = 4.45 Years 4 Years, 5 Months & 12 days PBP =3 + 70,000 – 65,000 30,000 = 3+ 5,000 30,000 = 3+ 0.14 = 3.14 3 Year,1 Month & 20 days

  21. Calculation Of Net Present Value Project A

  22. Calculation Of Net Present Value Project B

  23. Net Present Value (NPV) Project A Project B NPV = Total Present Value – Initial Investment = 70,474 – 90,000 = -19,526 NPV = Total Present Value – Initial Investment = 95,635 – 70,000 = 25,635

  24. Steps for Calculation of IRR • Calculate average cash flow • Divide Initial Investment by answer of above step • Find the Answer of above step in table and see % of rate • Calculate total present value with the help of above found rate • Get another total present value with another supposed rate. • Apply the formula

  25. Calculation of Avg. Cash Flow Project A Project B

  26. Step 1 : Average Cash Inflow Project A Project B Average = Total Cash Inflow No. of Years = 1,01,000 5 = 20,200 Average = Total Cash Inflow No. of Years = 1,40,000 5 = 28,000

  27. Step 2: Division Project A Project B Divide Initial Investment by answer of previous step. = 90,000 20,200 = 4.45 Divide Initial Investment by answer of previous step. = 70,000 28,000 = 2.5

  28. Step 3 : See The Table Project A Project B 28% 4%

  29. Project A Project B

  30. Step 4 & 5: Calculate NPV Project A Project B Present value with 4% = 88,979 – 90,000 = -1021 Present value with 2% =94,694 – 90,000 = 4694 Present value with 28% = 62,920 – 70,000 = -7080 Present value with 23% = 71020 – 70000 = 1020

  31. Step 6: Apply The Formula Project A Project B IRR= 2%+2% 4694 4694 + 1021 =2%+2% 4694 5715 = 2% + 2% ( 0.8213) = 2% + 1.64% = 3.64% IRR = 23%+5% 1020 1020 + 7080 =23%+5% 1020 8100 = 23%+5% (0.125925) = 23% + 0.63% = 23.62%

  32. Profitability Index Project A Project B PI = Net Present Value Initial Investment = 70,474 90,000 = 0.78 PI = Net Present Value Initial Investment = 95,635 70,000 = 1.36

  33. Conclusion On the basis of above Techniques The Project B is Not Beneficial for Company ABC.

  34. Thank you!!!

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