Capital Budgeting

and
Cash Flow Projection
TOPIC 5
BDPW3103 INTRODUCTORY FINANCE
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Capital Budgeting?
A process of planning the
asset spending that is the
cash flow expected to be
received after a year.
Evaluation will be undertaken
on proposals of projects to
determine the suitability of
those projects to achieve the
firms objective.
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Capital Budgeting: WHY IMPORTANT?

Every decision made regarding capital budgeting has significant

implications to both the cash flow expected to be received by the
firm and to the cash flow risk.

This is because the decision on capital budgeting involves

investment of assets that is more than one year.

Therefore, it is important that a firm makes an accurate

projection of the expected return.

Capital budgeting is part of the process of strategic management.

Decision regarding capital budgeting of the firm shall point to the

strategic direction of the firm.

The timing of an investment project is important.

Evaluation of Capital Budgeting Project

Steps:

Methods in Evaluating
Project
Accounting Rate of Return

Methods in Evaluating
Project
Accounting Rate of Return
An advantage of using Accounting Rate of Return (ARR):

It is easy to understand and to be used. The concept of income, book

value and rate of return is a simple concept to understand by managers.

The following are the disadvantages of using accounting rate of return

(ARR):
(i) It does not take into account the present value of money ;
(ii) It uses accounting measurement and not cash flow; and
(iii) Different methods of calculation may cause different decisions made.
By using equation 1, the project may be accepted but by using equation 2 it
may be rejected.
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Methods in Evaluating
Project
Payback Period

Methods in Evaluating
Project
Payback Period

Methods in Evaluating
Project
Payback Period

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Methods in Evaluating
Project
Net Present Value

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Methods in Evaluating
Project
Net Present Value

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Methods in Evaluating
Project
Internal Rate of Return

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Methods in Evaluating
Project
Internal Rate of Return

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Exercise1:

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Exercise2:

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Exercise3:

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