Business-Finance

Assignment Submitted To

Ma`am Shamim
Submitted By

Muhammad

NABEEL MUGHAL

Roll No

21202001-010
Department

Business Administration

Semester 4th

Discipline

BBA-Honors
Session

2021-2025

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 Capital Budgeting:

What is Capital?
Capital is a broad term that can describe anything that confers value or benefit to its owners, such
as a factory and its machinery, intellectual property like patents, or the financial assets of a
business or an individual.

What is Budget?

A budget is a spending plan based on income and expenses. In other words, it's an estimate of
how much money you'll make and spend over a certain period of time, such as a month or year.
(Or, if you're accounting for the incoming and outgoing money of everyone in your household,
that's a family budget.)

Capital Budgeting:
Capital budgeting is a method of estimating the financial viability of a capital investment over
the life of the investment. Unlike some other types of investment analysis, capital budgeting
focuses on cash flows rather than profits.
Non-Discounting Criteria:

 Pay-back Period (PBP):

The payback period method is the simplest way to budget for a new project. It measures the
amount of time it will take to earn enough cash inflows from your project to recover what you
invested.

 Average rate of return (ARR):

The accounting rate of return (ARR) method is also known as the return on investment (ROI)
method. It uses accounting information obtained from financial statements to measure the
profitability of a possible investment. Some companies prefer the ARR method since it considers
the project’s earnings over its entire economic life.

Example: If a new machine being considered for purchases have an average investment cost of
$ 100,000 and generate an average annual profit increase of $ 20,000, the accounting rate of
return (ARR) will be 20%.

×100  $100,000 20%.

Average annual profit increases $20,000
ARR  Average investment cost

Discounting Criteria:
Discounted cash flow (DCF) methods are also known as “time-adjusted techniques.” They
consider the time value of money while evaluating the costs and benefits of a project. The cash
flows associated with the project are discounted at the cost of capital. These methods also take
into account all benefits and costs occurring during the project’s life cycle.

 Net present value (NPV):

The net present value capital budgeting method measures how profitable you can expect a
project to be. When using this method, any project with a positive net present value is acceptable,
while any project with a negative net present value is not acceptable. The NPV method is one of
the most popular capital budgeting methods because it helps you to choose the most profitable
projects or investments.

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Example: An investor made an investment of $500 in property and gets back $570 the next
year. If the rate of return is 10%. Calculate the net present value.

Given:

Amount invested = $500

Money received after a year = $570

Rate of return = 10% = 0.1

Using net present value formula,

Present value, PV = cash value at time period (1+rate of return) time period cash value at time
period (1+rate of return) time period

PV = $ 570(1+0.1)1$570(1+0.1)1

PV = $ 570/1.1

PV = $ 518.18

Net Present Value = $ 518.18 − $ 500.00 = $18.18

Therefore, for 10% rate of return, investment has NPV = $18.18.

 Internal rate of return (IRR):

The internal rate of return method measures the return percentage you can expect to receive from
a specific project. When using this method, the more the rate of return percentage exceeds the
project's initial capital investment percentage, the more appealing the project becomes. It is
common for a company to use the IRR method to choose between conflicting project options.

Example: You invest $500 now, and get back $570 next year. Use an Interest Rate of 10% to
work out the NPV.

You invest $500 now, so PV = −$500.00. Money In: $570 next year. ...
PV = $518.18 (to nearest cent) And the Net Amount is:
Net Present Value = $518.18 − $500.00 = $18.18

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