CAPITAL BUDGETING (investment concept) c.

Avoidable cost of immediate repairs on old

- The process of identifying, evaluating, planning, asset to be replace, net of tax
and financing capital investment projects of an
organization. b. Cash Returns – Cash income vs net income
Cash returns vs Net returns (income)
Project Classification Sales xxx
1. Replacement: Maintenance of Business Expenses (COGS+OPEX) (xxx)
2. Replacement: Cost Reduction Operating Income xxx
3. Expansion of Existing Products or Markets Income Taxes (xxx)
4. Safety and Environmental Projects Net Income xxx
5. Other Projects (Office Buildings, Parking lots, executive Depreciation Expenses xxx
Aircraft) Cash Returns xxx

Capital Investment Projects c. Terminal Value/ discount rate – Residual/Scrap value

1. Large commitments of resources – malaki ang amount
2. Long term commitments 2. Cost of Capital
3. More difficult to reverse than short term decision (Hurdle Rate, Required Rate of return, Cut-off Rate,
4. Involve so much risk and uncertainty Opportunity Cost)

Capital Budgeting Process

- Determines the allocation of funds in order of
priority.
Steps
1. Identification of potential projects
2. Estimation of cost and benefits
3. Determine the riskiness of the projected cash flows. 3. Acceptance Criteria
4. Development of the project proposal
5. Development of capital budget Common Evaluation Techniques
6. Re-evaluation of projects Methods that do not consider the time value of money
1. Payback (PB) – how long to recover your investment
Factors Affecting Long Term Decisions based on annual cash return
1. Estimated Cash Flows

a. Net Investment
= Costs (Cash outflows) – Savings (Cash Inflows)
1. Costs or Cash outflows (add)
a. Initial cash outlay covering all expenditures
b. Working capital requirement to operate the
project at the desired level
c. Market value of an existing, currently idle asset,
2. Bailout (BO) – same sa 1, pero yung annual return
which will be transferred to or utilized on the
inaadd sa estimated salvage value at the end of each
operations.
year.
3. Accounting Rate of Return (ARR) – also called book
2. Savings or Cash Inflows (deduct)
value of return/annual rate of return/average annual
a. Trade-in value of old asset (in case of
return of investment/ROI in FS analysis
replacement)
b. Proceeds from sale of old asset to be disposed
(less tax, if there is gain. Add tax savings, if there is
loss on sale)
 /(reached inv. recovered value – recovered value before
reach inv) or parang sa payback pero kasama salvage
value

NPV = PV of Cash return – Investment

DPB = year bago mareach yung investment +
(investment – Cum. PV before reach inv.) / PV of CR in
the year nagreach
Methods that consider the time value of money PI = PV of Cash return / Investment
1. Net Present Value (NPV) – compare yung value ng
investment today against sa value ng investment natin sa
future. Cash returns sa future, ibabalik into present.
Present Value of cash returns - Investment

2. Profitability Index (PI) –

Present Value of cash returns / investment
3. Discounted Payback (DPB)
4. Discounted Cash Flow Rate of Return or Internal Rate
of Return (IRR)

Payback = Investment/Cash returns kapag same same cr

Pag hindi same = year bago mareach yung investment +
(investment – Cum. cr before reach inv.) / CR in the year
nagreach or year bago mareach yung investment +
(kulang na inv / yung cash inflow nung sumunod na
taon)
Payback Reciprocal - percentage of investment recovered
(add
back dep. Exp) = 1 / Payback
ARR = percentage of investment recovered (deduct
Dep.Exp) simple,, net income/ net investment,, average
inv,, inv + salvage value / 2
Net Income / Investment
Bail Out = year bago mareach yung investment +
(Investment – recovered value before reach inv.)