GE Capital India

Capital Budgeting

Manish Tembhurkar
Shiv Shakti Ranjan
October 11, 2011

Agenda

PricewaterhouseCoopers Private Ltd

Capital Budgeting The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions.

The firms investment decisions would generally include

expansion, acquisition,

modernisation and
replacement of assets. Sale of a division or business (divestment) is also an investment decision.

Investment Decision
Investment decisions are classified as follows: Mutually exclusive investments

Independent investments
Contingent investments

Investment evaluation criteria

Estimation of cash flows

Estimation of the required rate of return (the opportunity cost of capital)

Application of a decision rule for making the choice

Evaluation Methods Discounted Cash Flow Criteria (time value of money is considered) Net Present Value (NPV) Internal Rate of Return (IRR) Profitability Index (PI)

Non Discounted Cash flow

Payback Period (PB) Discounted payback period (DPB)

Accounting Rate of Return (ARR)

Net Present Value (NPV) 1. Present value of Projects Cash flows is calculated using the opportunity cost of capital as the discount rate. 2. Net present value (NPV) is found out by subtracting present value of cash outflows from present value of cash inflows.

3. The project is accepted if NPV is positive (i.e., NPV > 0).

Internal Rate of Return (IRR) 1. The internal rate of return (IRR) is the rate that equates the investment outlay with the present value of cash inflow received after one period. 2. rate of return (r) is the discount rate which makes NPV = 0.

3. Accept the project when r>k

4. Eg.

Profitability Index 1. Profitability index is the ratio of the present value of cash inflows, at the required rate of return, to the initial cash outflow of the investment. 2. The formula for calculating benefit-cost ratio or profitability index is as follows:

3. Accept the project when PI is greater than one. PI > 1

Payback Method 1. Payback is the number of years required to recover the original cash outlay invested in a project. 2. the payback period can be computed by dividing cash outlay by the annual cash inflow. That is:

C0 Initial Investment Payback = Annual Cash Inflow C

3. The project would be accepted if its payback period is less than the maximum or standard payback period set by management.

Discounted Payback period 1. discounted payback period is the number of periods taken in recovering the investment outlay on the present value basis.

Thank You