Capital Budgeting Decisions

Techniques of Capital Budgeting

Online Session
20-04-2020
Payback Period
It is the length of time required to recover the
initial cash outlay. It is the period which is
required to get back the original cost of
investments by annual savings.

Computation depends on whether the cash flow

accrues at even rate (equal cash inflow) or at
uneven rate (unequal cash inflow)

2 Vivek G S PGDMS&RC, S.I.T., Tumkur

Payback Period – Equal Cash Flows
Payback Period = Initial outlay or Initial investment
Annual Savings or Annual cash inflow

Problems:
1. A project costs Rs.2,00,000 and yields an annual cash
inflow of Rs.40,000 for 8 years. Calculate its pay – back
period.
2. A project cost Rs.5,00,000 and yields annually a profit of
Rs.80,000 after depreciation at 12% p.a. but before tax
of 50%. Calculate the pay back period.

3 Vivek G S PGDMS&RC, S.I.T., Tumkur

Payback Period - Unequal cash inflow
The payback period may be calculated by adding up the cash
inflows until the total is equal to the initial cash investment.

B
Payback period = E +
C
E = No. of years immediately preceding the year of
recovery
B = Balance amount of investments to be recovered
C = Savings (cash inflow) during the year of final recovery

4 Vivek G S PGDMS&RC, S.I.T., Tumkur

Accounting Rate of Return
Accounting rate of return (also known as simple rate of
return) is the ratio of estimated accounting profit of a
project to the average investment made in the project. ARR
is used in investment appraisal.

Average Accounting Profit

ARR =
Average Investment

Accept the project only if its ARR is equal to or greater

than the required accounting rate of return. In case of
mutually exclusive projects, accept the one with highest
ARR.

5 Vivek G S PGDMS&RC, S.I.T., Tumkur

 Thank You

6 Vivek G S, PGDMS&RC, S.I.T., Tumkur