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Aniruddha Gachake
  

O Êecisions involving huge capital and time

at the same time gives rise to revenues
over a number of years.

CAPITAL BUÊGETING

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O Capital budgeting is a required managerial tool.
One duty of a financial manager is to choose
investments with satisfactory cash flows and
rates of return. Therefore a financial manager
must be able to decide whether an investment
is worth undertaking and be able to choose
intelligently between two or more alternatives.
To do this a sound system procedure to
evaluate, compare and select projects is
needed. This procedure is called capital
budgeting.
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O Êebt Equity Study
O Better capital management

Planning implementation control

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O x. project size ±
* Small
* Large
2. type of benefit to the firm ±
* an increase in cash flow
* a decrease in risk
* an indirect benefit
3. degree of dependence ±
* mutually exclusive projects
* complementary projects
* substitute projects
4. degree of statistical dependence ±
* positive dependence
* negative dependence
5. type of cash flow ±
* conventional cash flow ± only one change in the cash floe sign
* Non conventional cash flow ± more than one change in the cash flow sign
a


a


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O A company may raise funds from the following sources
±
‡ New issue
‡ Right issue
‡ Loan stock
‡ Retained earnings
‡ Bank borrowings
‡ Government sources
‡ Leasing
‡ Hire purchase
‡ Venture capital
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O Companies specify an overall limit on the

total budget for capital spending, this
process of deciding the limit of capital
spending is known as capital rationing.
 




O Hard capital rationing ± This arises when

constraints are externally determined.
This will not occur under perfect market.
O Soft capital rationing ± This arises with
internal management imposed limits on
investment expenditure.








O External reasons ± These arises when a firm is unable
to borrow from the outside. For example if the firm is
under financial distress, tight credit conditions or the
firm has a new unproven product. Similarly borrowing
limits imposed by banks particularly in relation to
smaller firms and individuals.
O Internal reasons-
reasons-
‡ Private owned company
‡ Êivisional constraint
‡ Human resource limitations
‡ Êebt constraints
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O Ñe calculate a company¶s weighted

average cost of capital using a 3 step
process ±
‡ Cost of capital components
‡ Capital structure
‡ Ñeighting the components

  
 

 

O The feasibility of the project can be

judged by ±
‡ Market analysis
‡ Technical analysis
‡ Financial analysis
‡ Economic analysis
‡ Environmental analysis

 





O Êeals with two questions ±
‡ Êemand for the proposed product
‡ Market share of the project under appraisal.
To answer these questions the market analyst require
following information ±
‡ Consumption trend
‡ Supply position
‡ Production possibilities and constraints
‡ Cost structure
‡ Elasticity of demand
‡ Consumer behaviour
 








O Analysis of the technical and engineering

aspects of the project.











O To judge the financial viability of the

project.
Tools ±
‡ Break even point
‡ Cost of capital
‡ Budgeting techniques etc.









O Economic analysis also referred to as

social cost benefit analysis, is concerned
with judging a project from the larger
social point of view.

  








O Evaluating the project considering the

environmental issues.
   





 
    


O Pay back method or payback period ±
The payback period is the number of years
required to return the original investment
from the net cash flow. ( net operating
income after taxes plus depreciation ).

 






O Pay Back Period = cash outlay/ Annual

cash inflows
 
 

O Accounting rate of return = Average net

profit / Average Annual investment


  


O Profitability index = PV of future cash

flows/ PV of initial investment
O Êate ± x3/5/20x0