Podcast
Questions and Answers
What is capital budgeting?
What is capital budgeting?
Evaluation and decision-making about projects to maximize shareholder wealth.
Which of the following is NOT a method of financial appraisal in capital budgeting?
Which of the following is NOT a method of financial appraisal in capital budgeting?
Capital expenditure refers to the ongoing expenses associated with the operation of a project.
Capital expenditure refers to the ongoing expenses associated with the operation of a project.
False
What does the term 'Initial Cash Outlay' refer to?
What does the term 'Initial Cash Outlay' refer to?
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According to capital budgeting, benefits must be worth more than the __________.
According to capital budgeting, benefits must be worth more than the __________.
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What must be included when estimating after-tax incremental cash flows?
What must be included when estimating after-tax incremental cash flows?
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In capital budgeting, which of the following correctly describes mutually exclusive projects?
In capital budgeting, which of the following correctly describes mutually exclusive projects?
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What does depreciation represent in capital budgeting?
What does depreciation represent in capital budgeting?
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Opportunity costs should be ignored in project evaluations.
Opportunity costs should be ignored in project evaluations.
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What financial metrics are commonly used in capital budgeting?
What financial metrics are commonly used in capital budgeting?
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Study Notes
Capital Budgeting Overview
- Capital budgeting is essential for evaluating and deciding on long-term project investments that generate cash flows over multiple years.
- Goals include maximizing shareholder wealth and ensuring benefits outweigh costs.
- Forecasting future cash flows is a critical step in project evaluation.
Key Concepts in Capital Budgeting
- Time Value of Money: Recognizes that money available today is worth more than the same amount in the future.
- Compounding and Discounting: Methods to determine future and present values of cash flows.
- Future Value: Calculated for single and multiple cash flows.
- Present Value: Assessment for single and multiple flows, including annuities.
Capital Expenditure
- Also known as Investment Outlay; represents the initial monetary commitment to a project.
Project Classification
- Mutually Exclusive Projects: Choose only one project from multiple options.
- Independent Projects: Accept all profitable projects without preference.
Types of Investment Proposal Projects
- New product development or expansion.
- Replacement of outdated equipment/buildings.
- Research and development initiatives.
- Exploration projects.
- Safety and pollution-related initiatives.
Calculating After-Tax Incremental Cash Flows
- Exclude sunk costs from evaluations.
- Include opportunity costs and project-driven changes in working capital.
- Factor in inflation effects.
Tax Considerations and Depreciation
- Depreciation systematically allocates asset costs over time for reporting purposes.
- Considered a non-cash expense.
- Depreciable Basis: Comprised of the asset cost plus capitalized expenditures.
Essential Considerations for Cash Flow Analysis
- Determine expected cash flows, including investment outlay, operating cash flow, and terminal cash flow.
- Assess project risk and select the appropriate discount rate.
Cash Flow Components
- Initial Cash Outlay: Total amount of capital needed to initiate the project.
- Cash Inflows: Revenue generated from the project over its duration.
Initial Cash Outlay Calculation
- Formula: Initial Cash Outlay = Cost of Asset + Capitalized Expenditures - Subsidy.
- Includes costs like the acquisition price and relevant capital expenditures.
Operating Cash Inflows
- Sales revenue minus operating expenses leads to earnings before interest, depreciation, and tax (EBID&T).
- Subsequent deductions of interest, depreciation, and taxes yield profit after tax (PAT).
- Cash flow calculation includes PAT plus depreciation to determine cash inflow after tax (CFAT).
Cash Flow Example Calculation
- Investment proposal at Rs.10,00,000 with a lifespan of 5 years and varying cash inflows annually.
- Operating expenses consistent at 40% of revenue.
- Interest charges reduce overall profit, while tax calculations further refine net profits.
- Depreciation is consistently applied to assess cash flow over the project's life.
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Description
Explore the fundamental concepts of capital budgeting techniques, including the time value of money, compounding, and discounting. This quiz covers essential financial appraisal methods such as Payback Period, NPV, and IRR, providing a comprehensive overview of capital expenditures in long-term investments.
