CAPITAL BUDGETING

INTRODUCTION
y Capital budgeting (or investment appraisal) is the

planning process used to determine whether a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital , or investment, expenditures.

METHODS
y y y y y y

Accounting rate of return Net present value Profitability index Internal rate of return Modified internal rate of return Equivalent annuity

ACCOUNTING RATE OF RETURN

y Ratio that expresses the earnings before interest and

taxes (EBIT) as a percentage of the capital employed at the end of an accounting period. y ARR calculates the return, generated from net income of the proposed capital investment. y ARR does not take into account the time value of money the value of cashflows does not diminish with time as is the case with NPV and IRR.

CALCULATION OF ARR