capital budgeting notes.pdf

HEC Group of Institutions, HARIDWAR Online Notes for the Subject – Financial Management B.Com Vth semester Topic Name- Capital Budgeting CAPITAL BUDGETING : Capital Budgeting is the most impor...

HEC Group of Institutions, HARIDWAR Online Notes for the Subject – Financial Management B.Com Vth semester Topic Name- Capital Budgeting CAPITAL BUDGETING : Capital Budgeting is the most important and complex problem of managerial decision making. Capital budgeting is planning of expenditures on such projects whose benefits are accrued to the concern for many future years.It is concerned with long term planning of financial resources of the concern. The most profitable project proposal is selected by comparing the estimated costs of different capital proposals with their benefits by appropriate device and efforts are made to maximise profits of the concern. NEED FOR CAPITAL BUDGETING 1. HIGH COST: All the capital projects require high investments hence it is necessary for the concern to effectively evaluate the project before selection. 2. INVESTMENT IS PERMANENTLY BLOCKED: As the investments in projects are permanently blocked careful planning is essential. 3. EFFECT ON PROFITABILITY AND FINANCIAL POSITION: Capital investments are to be carefully planned as concerns financial profitability is dependent on the capital investment. 4.UNCERTAINTY AND RISK : As the investments involve greater amount of risk the concern has to take to take the decision of investments very carefully. METHODS USED FOR THE VALUATION OF INVESTMENT PROPOSALS 1. URGENCY METHOD: No predetermined plan is necessary for urgency method. Under this method project is selected on the basis of degree of selection. 2. PAY BACK PERIOD METHOD: In this method time period of recovery of cost of capital by its own cash earnings or net cash inflows. CALCULATION OF PAY BACK PERIOD A) In the case of even cash flow: If cash inflows from investments are uniform throughout the life of investment. Pay- back period = Original investment Annual cash inflow or cash savings after tax Eg: Initial investment on the project is ₹ 100000.cash inflow throughout the year is ₹ 25000. Calculate pay back period. Pay back period =Initial investment Annual Cash Flow = 100000 25000 = 4 Years B) In the case of uneven cash flow: If cash inflows from investments are not uniform each year. PAY BACK PERIOD =E+B C E stands for number of years immediately proceeding the year of final recovery B stands for balance of amount to be recovered C stands for cash flow during the year of final recovery E.g.: A project with an outlay of ₹ 100000 yields₹ 30000, ₹ 40000, and ₹ 60000 in 1st 2nd and 3rd year calculate payback period. Pay –back period = E+B = 100000-90000 =3 years and 2 months C 60000 Note - Dear Student, If any problem regarding this topic please contact 7579088491 RASHMI SAXENA