Should we build this plant?

Presented by Yogesh Nitin Sanjay Pranit Deepak Prashant

 Capital Budgeting is the decision that

managers use to identify those projects that add to the firms value and such as the most important decision take a finance managers and their staff. Capital Budgeting is the process of determining which real investment projects should be accepted and given an allocation of funds from the firm.

Capital budgeting addresses the issue of

strategic long-term investment decisions. Capital budgeting can be defined as the process of analyzing, evaluating, and deciding whether resources should be allocated to a project or not. Process of capital budgeting ensure optimal allocation of resources and helps management work towards the goal of shareholder wealth maximization.

Involve massive investment of

resources Have long-term implications for the firm Involve uncertainty and risk for the firm

Due to the above factors, capital budgeting Any firm that does not follow the capital

decisions become critical and must be evaluated very carefully. budgeting process will not be maximizing shareholder wealth. interests of shareholders.

management will not be acting in the best

Similarly, which company faced problems due
to bad capital budgeting, while Intel became global leader due to sound capital budgeting decisions in 1990s.

1. 2. 3. 4.

Payback Period Discounted Payback Period

Net Present Value

Internal Rate of Return

oThe amount of time needed to recover the

initial investment oThe number of years it takes including a fraction of the year to recover initial investment is called payback period oTo compute payback period, keep adding the cash flows till the sum equals initial investment

oSimilar to payback period approach with one

difference that it considers time value of money oThe amount of time needed to recover initial investment given the present value of cash inflows oKeep adding the discounted cash flows till the sum equals initial investment

oBased on the amount of cash

flows oThe amount of value added by a project oNPV equals the present value of cash inflows minus initial investment

oThe rate at which the net present value of cash

flows of a project is zero, I.e., the rate at which the present value of cash inflows equals initial investment

oProjects promised rate of return given initial

investment and cash flows

oConsistent with wealth maximization

oAccept a project if IRR more Cost of Capital

Investment Decision Reinvestment Real Assets Financial Manager

Financing Decision Refinancing Financial Markets

Returns from Investment

Returns to Security Holders

Capital Budgeting is used to make the Investment Decision

Example There are two projects A & B Dis @ 10% , Outflow 2000

Project A Year 1 2 3 4 inflow 500 600 900 500

Project B year 1 2 inflow 800 600

3
4

600
500

Calculation Project A
Yea r 1 2 3 4 inflow Dis @10% Yea r 455 496 676 342 1962 2000 -38

Calculation Project B
inflow Dis @10%

500 600 900 500

0.909 0.826 0.751 0.683 P.V - outflow N.P.V

1
2 3 4

800
600 600 500

0.909
0.826 0.751 0.683 P.V - outflow N.P.V

727
496 451 342 2016 2000 16

project A
There is a project A NPV is less than the outflow . The project should be rejected.

project B
There is a project A NPV is more than the outflow . The project should be accepted.

THANK YOU