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Investment Decision
Refers to commitments of resources made in
hope of realizing benefits that are expected to
occur over a reasonably long period of time in
the future.
Future success of a business depends on the
inv decisions made today.
It is of two types :
1. Investment decision affecting revenues.
2. Investment decision reducing costs.
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Classification of Projects :
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Capital Budgeting :
Meaning
of capital budgeting
Significance
Capital budgeting process
Investment criteria
Techniques of capital
budgeting
Problems.
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Meaning :
Pertains
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2.
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3.
4.
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The
follow
up,
comparison
of
actual
performance with original estimates not
only ensures better forecasting but also
helps in sharpening the techniques for
improving future forecasts.
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Availability of funds
Structure of capital
Taxation policy
Government policy
Immediate need of the project
Earnings
Capital return
Economical value of the project
Working capital
Accounting practice
Trend of earnings
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It
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Rs.
(250,000)
40,000
30,000
20,000
10,000
10,000
Investme
nt
Investme
nt
Profits
after tax.
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Solution :
PAT+ DEP
CFAT
CUM. CFAT
40,000+
42000
=82000 82000
30000+
42000
=72000 154,000
20,000+
42000
=62000 216,000
10,000+
=52000 268,000
THEREFORE
42000 PAYBACK PERIOD :
3YRS+
(34,000/52000)
= 3.65320,000
YEARS
5
10,000+
=52000
42000
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Decision criteria :
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Cons :
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Rs.
(250,000)
40,000
30,000
20,000
10,000
10,000
Investme
nt
Investme
nt
Profits
after tax.
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Solution
Here profits are after depreciation and taxes.
ARR =
estimated avg.net annual income after dep&
tax X 100
Initial Investment
Or Average profits after tax
Avg. Investment.
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Demerits :
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Homework Question :
Purchase price 80,000
2. Installation charges- 20,000
3. Estimated salvage value- 40,000
4. Useful life- 4 years
5. Working capital required- 10,000
6. Annual EBDT- 65,000
7. Tax Rate- 30%
Calculate ARR if the method of Depreciation is
a) SLM b)WDV
1.
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I- depreciation has been deducted from the earnings to reduce the tax
liability and then added back to determine the CFAT.
II- dep has not been added or subtracted only tax saving is added
since it results in cash inflow.
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a. Every
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a. Each
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a. Variable
cost : manufacturing ,
administrative , selling and distribution
expenses.
b.Incremental fixed cost.
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xxxx
xxxx
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A.
Sales units
B.
SP per units
C.
Total Sales
D.
(Variable Costs)
E.
Contribution
F.
G.
EBT (E-F)
H.
(tax)
I.
EAT (G-H)
J.
Add Depreciation
K.
CFAT (I+J)
L.
+Release of WC
M.
N.
O.34Total
MissYear.
Kirti Kiran, Asst professor, DMC
CFAT For the last
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Pros:
It recognizes the time value of money.
It considers the cash inflow of the entire project.
It estimates the present value of their cash
inflows by using a discount rate equal to the
cost of capital.
It is consistent with the objective of maximizing
the welfare of owners.
Cons:
It is very difficult to find and understand the
concept of cost of capital
It may not give reliable answers when dealing
with alternative projects under the conditions of
unequal lives of project.
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Question on NPV
2.
3.
4.
Subsidy Receivable from govt 50% now and 10% at the end of
1st year.
5.
6.
7.
8.
9.
10.
11.
WACC- 10%
12.
EBDT- 1yr NiL , 2nd 3rd 4th year- 500,000 each3 5th year Nil.
2.
3.
4.
Subsidy Receivable from govt 50% now and 10% at the end of 1st year.
5.
WC requirement at the beginning of 1st year, 2yr and 3rd year respectively
= 200,000 ; 300,000 ; and 250,000.
6.
7.
8.
9.
10.
11.
12.
WACC- 10%
13.
EBDT- 1yr Nil , 2nd 3rd 4th year- 500,000 each3 5th year Nil.
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Cons
Computation of IRR is tedious and difficult to
understand
Both NPV and IRR assume that the cash inflows
can be reinvested at the discounting rate in the
new projects. However, reinvestment of funds at
the cut off rate is more appropriate than at the
IRR.
IT may give results inconsistent with NPV
method. This is especially true in case of
mutually exclusive project.
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Note:
Depreciation = St.Line method
PBDT Tax is Cash inflow ( if the tax amount is
given)
PATBD = Cash inflow
Cash inflow- Scrap and working capital must be
added.
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Thank You
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