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r Capital budgeting is the process of making investment

decisions in capital expenditures.

r ÷xpenditure the benefits of which are expected to be
received over period of time exceeding one year.
r Capital budgeting is concerned with the allocation of
the firmǯs scarce financial resources among the
available investment opportunities.


r Út involves the exchange of current funds for the
benefits to be achieved in future
r The benefits are expected to be realised over a period
of years
r Funds are invested in long term activities
r Út involves generally huge funds
r They are irreversible decisions
r Út has significant effect on the profitability of the


r Marge investments
r Mong term commitment of funds
r Úrreversible in nature
r Mong term effect of profitability
r Difficulties of investment decisions
- decision extends to series of years
- Uncertainties of future
- Higher degree of risk
r National importance

r Údentification of investment proposals
r Screening the proposals
r ÷valuation of proposals
r Fixing priorities
r Final approval and preparation of capital expenditure
r Úmplementing proposal
r Performance review


r ased on revenue and cost
- Those which increase revenue
- Those which reduce cost
r Ún view of the investment proposals
- Accept/reject decisions
- Mutually exclusive project decisions
- Capital rationing decisions
r Traditional methods
- Pay-back period method
- Úmproved approach to pay-back period method
- Rate of return method or Accounting method
r Time adjusted methods or discounted methods
- Net present value method
- Únternal rate of return method
- Profitability index method


r Simple and easy to calculate

r Út saves in cost as it requires less time
r Suitable to a firm which has shortage of funds

r Út does not take into account the cash inflows earned

after pay back period, so that the true profitability
cannot be assessed
r This method ignores the time value of money
r Út does not consider the cost of capital
r Úts difficult to determine the minimum acceptable pay-
back period


r Simple and easy to operate

r Út uses entire earnings of a project
r This method uses the accounting concept of profits so
that it can be easily calculated from the financial data

r Út ignores the time value of money

r Út cannot be applied to a situation where investment in
a project is to be made in parts
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r Determine appropriate rate of interest

r Compute the present value of cash outlay
r Compute the present values of cash inflows
r Calculate NPV of the project by subtracting the NPV of
cash inflows from that of cash outflows
r Úf the NPV of cash inflows exceeds that of outflows,
then the project can be accepted

r Út recognizes the time value of money
r Út consider the earnings over entire life of the project
r Út is very difficult to compute as compared with the
traditional methods
r Út may not give good results while comparing projects
with unequal lives or unequal investment
r Út is not easy to determine the appropriate discount

r Út considers time value of money
r Út considers profitability of the project for its entire life
r Út is difficult method of evaluation
r The results of NPV method and ÚRR method may
differ in in some situations


r Urgency
r Degree of certainty
r Úntangible factors
r Megal factors
r Availability of funds
r Future earnings
r Research and development projects
r Cost considerations