Capital Budgeting is a tool for making a decision which help to increase a company's wealth & profit maximization

1. CAPITAL BUDGETING :
A tool for decision
making
PRESENTED BY:-
Yashdeep Kaur
Manisha Khandual
Swarup Ranjan Sahoo
Subhojit Chatterjee

2. CONTENTS
• INTRODUCTION TO DECISION MAKING
• WHAT IS DECISION MAKING?
• STEPS IN DECISION MAKING
• CAPITAL BUDGETING
• FEATURES OF CAPITAL BUDGETING
• IMPORTANCE OF CAPITAL BUDGETING
• PROCESS OF CAPITAL BUDGETING
• TECHNIQUES OF CAPITAL BUDGETING
• CONCLUSION
• REFERENCES

3. INTRODUCTION TO DECISION MAKING
Decision making is an integral part of modern
organisation. This is a continuous process of
managing any organisation or business
activity. Decisions are made at every level of
management to ensure that the organisational
or business goals are achieved, that is,
decision making is taken as primary function
of management.

4. WHAT IS DECISION MAKING?
Decision-making is a process of deciding
about something important or selecting an
appropriate solution from the available
alternatives for the concerned problem,
which is usually done by a group of people or
in an organisation.

5. STEPS IN DECISION-MAKING
There are certain steps which helps to make
decision. They are:-
• Define the problem
• Gathering data and collecting information
• Develop the alternatives
• Listing pros and cons of each alternative (whether
it will achieve the objective or not)
• Choosing best possible option
• Plan and execute
• Take follow-up actions

6. CAPITAL BUDGETING
• Capital budgeting is a process of evaluating
investments and huge expenses in order to
obtain the best returns on investment.
• The main objective of capital budgeting is to
evaluate the financial investments of the firm.
• Ideally, an organisation would like to invest in all
profitable projects but due to limitation on the
availability of capital an organisation has to
choose between different projects/investments,
so the capital budgeting is a tool for decision
making.

7. FEATURES OF CAPITAL BUDGETING
The features of capital budgeting are briefly explained below:
• Capital budgeting involves the investment of funds currently for
getting benefits in the future.
• Generally, the future benefits are spread over several years.
• The long term investment is fixed.
• The investments made in the project determines the financial
condition of business organisation in future.
• Each project involves huge amount of funds.
• Capital expenditure decisions are irreversible.
• The profitability of the business concern is based on the quantum
of investments made in the project.

8. IMPORTANCE OF CAPITAL BUDGETING
• LONG-TERM GOALS-For the growth & prosperity
of the business, long-term goals are very
important for any organization.
• INVOLVEMENT OF A LARGE NUMBER OF FUNDS-
Capital Investment requires a large number of
funds. As the companies have limited resources,
the company has to make a wise & correct
investment decision.
• IRREVERSIBLE DECISION-The capital Investment
decisions are generally irreversible as it requires
large amounts of funds.

9. IMPORTANCE OF CAPITAL
BUDGETING(contd.)
• MONITORING & CONTROLLING THE EXPENDITURE-Capital
budget carefully identifies the necessary
expenditure required for an investment project.
• DIFFICULTIES OF INVESTMENT DECISION-The long-term
investment decisions are difficult because it extends several
years beyond the current period. Uncertainty indicates a
higher degree of risk, so it must consider each proposal
very thoroughly.
• MAXIMIZATION OF WEALTH-Long-term investment decision
of the organization helps in safeguarding the interest of the
shareholder in the organization. This helps in the
maximization of wealth of the organisation.

10. PROCESS OF CAPITAL BUDGETING
• Project Identification And Generation
• Project Screening And Evaluation
• Project Selection
• Implementation
• Performance Review

11. PROCESS OF CAPITAL BUDGETING
• Project identification and generation:-The first step towards capital
budgeting is to generate a proposal for investments. There could be
various reasons for taking up investments in a business. It could be
addition of a new product line or expanding the existing one. It
could be a proposal to either increase the production or reduce the
costs of outputs.
• Project Screening and Evaluation:-This step mainly involves
selecting all correct criteria’s to judge the desirability of a proposal.
This has to match the objective of the firm to maximize its market
value. The tool of time value of money comes handy in this step.
• Project Selection:-There is no such defined method for the
selection of a proposal for investments as different businesses have
different requirements. That is why, the approval of an investment
proposal is done based on the selection criteria and screening
process which is defined for every firm keeping in mind the
objectives of the investment being undertaken.

12. PROCESS OF CAPITAL
BUDGETING(contd.)
• Implementation:-Money is spent and thus proposal is
implemented. The different responsibilities like
implementing the proposals, completion of the project
within the requisite time period and reduction of cost
are allotted. The management then takes up the task
of monitoring and containing the implementation of
the proposals.
• Performance review:-The final stage of capital
budgeting involves comparison of actual results with
the standard ones. The unfavorable results are
identified and removing the various difficulties of the
projects helps for future selection and execution of the
proposals.

13. TECHNIQUES OF CAPITAL BUDGETING
Methods of capital budgeting are:-
• Payback period
• Accounting rate of return
• Net present value method
• Internal rate of return
• Profitability index

14. TECHNIQUES OF CAPITAL
BUDGETING(contd)
1. Payback period method
In this technique, the entity calculates the
time period required to earn the initial
investment of the project or investment. The
project or investment with the shortest
duration is opted for.
Pay back period = Outflow
Annual inflow

15. For example-:
Year Profit before depreciation
1 Rs. 10,000
2 Rs. 11,000
3 Rs. 14,000
4 Rs. 15,000
5 Rs. 25,000
Project cost is Rs. 50,000.
Time is 5yrs.
Tax rate is 35%.
• The firm using straight line depreciating method to
estimate profit before tax from the proposed investment
proposal.

16. Initial investment
Subsequent cash in flow
1 2 3 4 5
Profit before
depreciation
10000 11000 14000 15000 25000
Less
depreciation
(minus)
10000 10000 10000 10000 10000
Profit before
tax
0 1000 4000 5000 15000
Add tax
(minus)
0 350 1400 1750 5250
Net profit 0 650 2600 3250 9750
Add
depreciation
10000 10000 10000 10000 10000
Cash inflow 10000 10650 12600 13250 19750

17. Terminal value = 0
Payback Method
Year Cash inflow
1 10000 10000
2 10650 20650
3 12600 33250
4 13250 46500
5 19750
=4 year+3500/19750
=4+0.18=4.18 Year
Company get their investment in 4.18 year

18. TECHNIQUES OF CAPITAL
BUDGETING(contd)
2. Net Present value
The net present value is calculated by taking the
difference between the present value of cash
inflows and the present value of cash outflows over
a period of time. The investment with a positive
NPV will be considered. In case there are multiple
projects, the project with a higher NPV is more
likely to be selected.
NPV= Present value of cash inflow – Present value of
cash inflow

19. We are taking the same above example to calculate NPV
• Net Present Value
Year Cash
inflow
PVF PV
0 (50000) 1 (50000)
1 10000 0.909 9090
2 10650 0.826 8797
3 12600 0.751 9463
4 13250 0.683 9056
5 19750 0.621 12265 48665
NPV (1335)

20. TECHNIQUES OF CAPITAL
BUDGETING(contd)
3. Accounting Rate of Return
In this technique, the total net income of the
investment is divided by the initial or average
investment to derive at the most profitable
investment.
• ARR = AVERAGE PROFIT ( AFTER TAX ) * 100
• AVERAGE INVESTMENT

21. Average income =(0+650+2600+3250+9750) =3250
5
Average investment= 50000 =25000
2
ARR = 3250 *100 =13%
25000

22. TECHNIQUES OF CAPITAL
BUDGETING(contd)
4. Internal Rate of Return (IRR)
For NPV computation a discount rate is used.
IRR is the rate at which the NPV becomes
zero. The project with higher IRR is usually
selected.

23. Internal rate of return
Year CF PVF10% PV 10 PV8% PV8
0 ( 50000) 1 (50000) 1 (50000)
1 10000 0.909 9090 0.926 9260
2 10650 0.526 8797 0.817 9127
3 12600 0.751 9463 0.794 10004
4 13250 0.673 9050 0.735 9730
5 19750 0.621 12265 0.681 13450
NPV=(1335) NPV = 1580
IRR=Lower rate + Positive NPV *Division discount rate
Positive NPV-Negative NPV
=8 + 1580 *2
1580+1335
=8+1580 *2
2915
=8+1.084
=9.084

24. TECHNIQUES OF CAPITAL
BUDGETING(contd)
5. Profitability Index
Profitability Index is the ratio of the present
value of future cash flows of the project to the
initial investment required for the project.
=Present value of cash inflow
Present value of cash outflow
=48665 =0.9733time
50000

25. CONCLUSION
Capital budgeting is a predominant function
of management. Right decisions taken can
lead the business to great heights. However, a
single wrong decision can inch the business
closer to shut down due to the number of
funds involved and the tenure of these
projects

26. REFERENCES
• R.K. Sharma, S.K. Gupta, Financial
management, Kalyani publishers
• G.S. Ready Financial management, Himalaya
publishers
• S.K.Banerjee, Financial management, S. Chand
and co.
• www.acountlearning.blogspot.com
• www.tutorialspoint.com
• www.Slideshare.net

27. THANK YOU