PHILIPPINE CHRISTIAN UNIVERSITY

Graduate School of Education

Capital
Budgeting
Techniques
Group VII
Presenter

Instructor’s Information Course Title

Ariel Dizon Pineda, CPA, MBA MASTER614 - Financial
Professor Management (w/ Excel Software)
Significance of Capital Budgeting
C
A Presenters:
P
I
T 1. Significance of Capital Budgeting - Corpuz, Nicka Abegail P.
A 2. Importance of Capital Budgeting - Urbanozo, Lara Monica C.
L 3. Definition of Capital Budgeting - Lalong-Abelgas, Mhonabeth S.
B 4. Payback Period - Matienzo, Junelle T.
U 5. Discounted Payback Period - Tamondong, Marry Grace D.
D 6. Accounting Rate of Return - Cacho, Karla Maritha C
G
E 7. Net Present Value - Ariente, Regine
T 8. Internal Rate of Return - Ortega, Josephine
I 9. Profitability Index - Castro, Liezl Andrea Keith E.
N
10. Conclusion/Summary - Ang, Radj
G
Significance of Capital Budgeting

• Capital budgeting provides a wide scope for

financial managers to evaluate different
projects in terms of their viability to be taken up
for investments and helps in exposing the risk
and uncertainty of different projects.

• It also keeps a check on over or under

investments. The management is provided with
an effective control on cost of capital
expenditure projects.

• Ultimately the fate of a business is decided on

how optimally the available resources are used.
Importance of Capital Budgeting
1) Long term investments involve risks: Capital expenditures
are long term investments which involve more financial risks.
2) Huge investments and irreversible ones: As the
investments are huge but the funds are limited, proper
planning through capital expenditure is a pre-requisite.
3) Long run in the business: Capital budgeting reduces the
costs as well as brings changes in the profitability of the
company.
Definition of Capital Budgeting
Capital Budgeting is the process a
business undertakes to evaluate
major projects or investments. This
process is used to create a
quantitative view of each proposed
fixed asset investment, thereby giving
a rational basis for making a
judgement.
Source: https://www.accountingtools.com
https://www.investopedia.com
Payback Period

Payback period is a method refers to the

period in which the proposal will generate
cash to recover the initial investment made.
It purely emphasizes on the cash inflows,
economic life of the project and the
investment made in the project, with no
consideration to time value of money.
Discounted Payback Period
• The discounted payback period is a modified
version of the payback period that accounts
for the time value of money.
• Both metrics are used to calculate the
amount of time that it will take for a project to
“break even,” or to get the point where the
net cash flows generated cover the initial
cost of the project.
• The shorter the discounted payback period,
the quicker the project generates cash
inflows and breaks even.
Discounted Payback Period
• Discount (i.e., bring to the present value)
the net cash flows that will occur during
each year of the project.
• Subtract the discounted cash flows from
the initial cost figure in order to obtain the
discounted payback period. Once we’ve
calculated the discounted cash flows for
each period of the project, we can
subtract them from the initial cost figure
until we arrive at zero.

(Source: https://corporatefinanceinstitute.com/resources/valuation/discounted-payback-period/)
Accounting Rate of Return Method (ARR)

This method helps to overcome the disadvantages of the

payback method. The rate of return is expressed as a
percentage of the earnings of the investment in a particular
project. It works on the criteria that any project having ARR
higher than the minimum rate established by the management
will be considered and those below the predetermined rate are
rejected.
Accounting Rate of Return Method (ARR)

This method takes into account the entire economic life of a

project providing a better means of comparison. It also ensures
compensation of expected profitability of projects through the
concept of net earnings. however, this method also ignores time
value of money and doesn’t consider the length of life of the
projects. Also it is not consistent with the firm’s objective of
maximizing the market value of shares.

ARR=Average income/Average investment

Discounted Cash Flow Method

The discounted cash flow technique calculates

the cash inflow and outflow through the life of an
asset. These are then discounted through a
discounting factor. The discounted cash inflows and
outflows are then compared. this technique takes
into account the interest factor and the return after
the payback period.
 Net Present
Value
● The Net Present Value, or NPV Model, is one of the widely used methods for evaluating capital
investment proposals.
● The present values of the cash inflow are compared to the original investment.
● This method considers the time value of money and is consistent with the objective of maximizing
profits for the owners.
● It provides an absolute measure of a project’s worth because it measures the total present value of peso
return. it also works equally well for independent projects as it does for choosing among mutually
exclusive projects.
● The advantage of using the NPV are that it considers the magnitude and timing of cash flows, provide an
objective criterion for decision making which maximizes shareholder wealth, and is the most
conceptually correct capital budgeting approach.
● The disadvantages of using the NPV are that it is more difficult to compute than unsophisticated methods
and its meaning is difficult to interpret because the NPV does not provide a measure of projects actual
rate of return.

NPV = PRESENT VALUE OF BENEFITS (PVB) - PRESENT VALUE OF COSTS (PVC)

Source/s:
Basic Financial Management by Ariel Dizon Pineda, CPA, MBA
Financial Management, Comprehensive Volume (2019-2022) by Cabrera
Internal Rate of Return (IRR)
● Internal rate of return (IRR) is the percentage of
returns that a project will generate within a period
to cover its initial investment. It is attained when
the Net Present Value (NPV) of the project
amounts to zero.
● IRR is one of several well-known formulas used to
evaluate prospective investments. It allows you to
calculate an investment's potential gains and
determine if it's a worthwhile use of your
company's funds.
● It facilitates the comparison of different investment
options and projects. Based on the IRR, the most
feasible and profitable options are chosen.
● An IRR higher than the discount rate signifies a
profitable investment opportunity.
● Essentially, the IRR rule is a guideline for deciding whether to proceed with a project or
investment. The higher the projected IRR on a project—and the greater the amount it
exceeds the cost of capital—the more net cash the project generates for the company.
Meaning, if the IRR is higher than the cost of capital, the project looks profitable and
management should proceed with it. On the other hand, if the IRR is lower than the cost of
capital, the rule declares that the best course of action is to forego the project or
investment.
● If you're calculating IRR manually, it takes trial and error until the NPV equals zero.

Internal Rate of Return Formula

Profitability Index

It is the ratio of the present value of future

cash benefits, at the required rate of return to
the initial cash outflow of the investment. It
may be gross or net, net being simply gross
minus one.
Profitability Index
is a financial tool which tells us whether an investment should be accepted or
rejected. It uses the time value concept of money.

All projects with PI > 1.0 is ACCEPTED

NPV UPFRONT PROFITABILITY

INVESTMENT INDEX

PROJECT A 650 580 1.12

PROJECT B 625 600 1.04

PROJECT C 875 750 1.17

Budget = 800