1.

CAPITAL INVESTMENT-
IMPORTANCE
 HAS LONG TERM IMPACT

 QUANTUM OF FUND INVOLVEMENT

GENERALLY LARGE

 DIFFICULT TO GET GOOD RESALE

VALUE, MAKING SUCH INVESTMENTS
QUITE IRREVERSIBLE
 2.CAPITAL INVESTMENT-TYPES

 REPLACEMENT

 EXPANSION

 DIVERSIFICATION -IN RELATED LINES

 DIVERSIFICATION- IN UNRELATED
LINES
 3.CAPITAL INVESTMENT-
CATEGORIES
 MUTUALLY EXCLUSIVE-SERVE SAME
PURPOSE-IF ONE IS CHOSEN OTHERS HAVE
TO BE EXCLUDED

 INDEPENDENT-SERVE DIFFERENT PURPOSES-

FUND PERMITTING ,ALL MAY BE TAKEN

 CONTINGENT-CHOICE OF ONE NECESSITATES

UNDERTAKING OF THE OTHER.
4.CAPITAL INVESTMENT-PROCESS
INVESTMENT IDEAS-INVESTMENT OPPORTUNUTIES HAVE TO
BE IDENTIFIED OR CREATED.

CASHFLOWS HAVE TO BE ESTIMATED-OVER THE EXPECTED

LIFE OF THE PROJECT

PROJECT EVALUATION-WHETHER BENEFITS SURPASS COSTS-

-WITH DUE WEIGHTAGE TO RISK AND TIME-VALUE OF MONEY

AUTHORISATION-FORMAL INCLUSION IN CAPITAL BUDGET

MONITORING-CONTROL TO KEEP ACTUAL EXPENDITURE

WITHIN BUDGET AND ALSO TO HELP MAKE MORE REALISTIC
ESTIMATES IN FUTURE.
 5.DISCOUNTING OF CASHFLOWS
CAPITAL INVESTMENTS AT PRESENT ,WOULD GENERATE
CASH INFLOWS AT POINTS IN TIME IN FUTURE, SPREAD
OVER EXPECTED LIFE OF THE PROJECT.

SUCH FUTURE CASHFLOWS WOULD BE WORTH LESS AT

PRESENT PRIMARILY BECAUSE OF
 INFLATION
 RISKS

TO MAKE COMPARISON OF SUCH FUTURE CASHFLOWS

(WITH PRESENT INVESTMENT) MEANINGFUL,THEY
HAVE TO BE DULY REDUCED TO BRING THEM DOWN
TO PRESENT VALUE-THIS IS REFERRED TO AS
DISCOUNTING OF CASHFLOW.
 6.CAPITAL INVESTMENT- EVALUATION
METHODS
METHODS CATEGORISED AS BELOW

NON DCF METHODS ( NO DISCOUNTING OF CASHFLOWS )

• PAYBACK PERIOD METHOD
• AVERAGE RATE OF RETURN (ARR)

DCF METHODS (DISCOUNTING OF CASHFLOWS DONE)

• NET PRESENT VALUE ( NPV)
• PROFITABILITY INDEX (PI)/BENEFIT COST RATIO(BCR)
• NET BENEFIT COST RATIO (NBCR)
• INTERNAL RATE OF RETURN (IRR)
• PAYBACK PERIOD METHOD
7.PAYBACK PERIOD METHOD
PAYBACK PERIOD IS THE TIME IT TAKES FOR RECOVERING THE INITIAL
INVESTMENT

YEAR PROJECT A PROJECT B

( CASHFLOW) (CASHFLOW)
0 (100) (100)
1 30 10
2 30 20
3 40 30
4 40 40
5 40 90
TOTAL 180 190

PROJECT A PREFERRED AS IT HAS SHORTER PAYBACK

PERIOD OF 3 YEARS COMPARED TO 4 YEARS OF PROJECT B.
 8.PAYBACK PERIOD METHOD
- PROS AND CONS
 ADVANTAGES
• MINIMISES RISK AS IT AIMS AT FASTER
RECOVERY OF INITIAL INVESTMENT
• EASY TO CALCULATE

 DISADVANTAGES
• NO DISCOUNTING OF CASHFLOWS
• DOES NOT LOOK BEYOND PAYBACK PERIOD.
MORE LUCRATIVE PROJECTS MAY BE
REJECTED SIMPLY BECAUSE THEY HAVE
LONGER PAYBACK PERIODS.(PROJECT B IN
THE PREVIOUS TABULATION)
9.AVERAGE RATE OF RETURN(ARR)
ARR = AVERAGE PROFIT AFTER TAX X 100 %
AVERAGE INVESTMENT

IF INITIAL INVESTMENT IS 2 LAKHS AND PAT FOR 5 SUCCESSIVE

YEARS ARE 30,000/40,000/45,000/65,000/70,000

THEN , AVERAGE PAT= 2,50,000 = 50,000

5
AVERAGE INVESTMENT = 2,00,000 = 1,00,000
2
ARR = 50,000 X 100 = 50 %
1,00,000

PROJECTS WITH HIGHER ARR PREFERRED.

 10.AVERAGE RATE OF RETURN
- PROS AND CONS

ADVANTAGES
• SIMPLE IN CALCULATION
• CONSIDERS ENTIRE LIFE OF PROJECT

DISADVANTAGES
• NO DISCOUNTING OF CASHFLOWS
 11.DISCOUNTING OF CASHFLOWS
-MECHANISM
 FUTURE CASH FLOWS HAVE TO BE
DISCOUNTED TO BRING THEM TO THEIR
PRESENT VALUES
 SUCH DISCOUNTING IS DONE BY DIVIDING BY
A NUMBER GREATER THAN 1
 DISCOUNTING DONE BY DIVIDING BY (1+K)
 K IS TERMED AS THE DISCOUNTING RATE
 K IS DEPENDENT UPON
• COST OF CAPITAL
• RISK ASSOCIATED WITH THE INVESTMENT
 12.NET PRESENT VALUE (NPV)
NPV = CF0 + CF1 + CF2 + ………………..+ CFn
(1+K)0 (1+K)1 (1+K)2 (1+K)n

WHERE

•CF = CASHFLOW OF A YEAR

•K = DISCOUNTING RATE
•n = EXPECTED LIFE OF THE PROJECT IN YEARS
•NPV = NET PRESENT VALUE
•YEAR 0 = YEAR IN WHICH INVESTMENT IS MADE AND THERE BEING
AN OUTFLOW OF CASH, CASHFLOW CONSIDERED NEGATIVE
•CASHFLOWS FROM YEAR 1 ONWARDS CONSIDERED POSITIVE
•PROJECT VIABLE IF NPV IS POSITIVE
 
 13.NET PRESENT VALUE (NPV)
NPV = CF0 + CF1 + CF2 + ………………..+ CFn
(1+K)0 (1+K)1 (1+K)2 (1+K)n
WHEN K IS SAY 10% = 0.1
  NPV = CF0 + CF1 + CF2 + ………………..+ CFn
(1+0.1)0 ( 1+0.1)1 (1+0.1)2 (1+0.1) n
 
NPV = 1.000 CF0 + 0.909 CF1 + 0.826 CF2 + 0.751CF3 + ……..
THE MULTIPLYING FACTORS ARE THE DISCOUNTING
FACTORS AT 10% DISCOUNTING RATE
 
1.000CF0 = CF0, DENOTES THE INITIAL INVESTMENT (I)
0.909 CF1 + 0.826 CF2 + 0.751CF3 + …….. DENOTES THE
PRESENT VALUE OF BENEFITS (PVB)
PROJECT ACCEPTABLE WHEN PVB GREATER THAN I
  OR WHEN NPV IS POSITIVE. WHERE NPV=PVB - I
 14.PROFITABILITY INDEX (PI)/
BENEFIT COST RATIO (BCR)

PI OR BCR = PVB
I

PROJECT VIABLE IF PI OR BCR

IS GREATER THAN 1
15.NET BENEFIT COST RATIO (NBCR)

NBCR = PVB - I
I

PROJECT VIABLE IF NBCR

IS GREATER THAN 0
 16.NPV/PI/NBCR
- PROS AND CONS

 ADVANTAGES
• CONSIDERS ENTIRE LIFE OF PROJECT
• DISCOUNTING OF CASHFLOWS DONE

 DISADVANTAGES
• SOMEWHAT COMPLEX IN
COMPUTATION
17.NPV/PI/NBCR- PROBLEM ON
YEAR PROJECT A - PROJECT B- DISCOUNTING
CASHFLOW CASHFLOW FACTOR

0 (100) (150) 1.000

1 20 28 0.909
2 30 56 0.826
3 40 68 0.751
4 60 89 0.683
5 80 118 0.621
BASED ON ABOVE FIGURES COMPUTE
NPV/PI/NBCR OF THE TWO PROJECTS
TIME VALUE OF MONEY – tables - PVIF
 18.NPV/PI/NBCR
- SOLUTION TO PROBLEM
YEAR PROJECT A PROJECT B DISCOUNTING PROJECT A PROJECT B
CASHFLOW CASHFLOW FACTOR DCF DCF
(1) (2) (3) (4) (5=2x4) (6=3x4)
0 (100) (150) 1.000 (100) (150)
1 20 28 0.909 18 25
2 30 56 0.826 25 46
3 40 68 0.751 30 51
4 60 89 0.683 41 61
5 80 118 0.621 50 73
PROJECT PVB I NPV PI NBCR=
=PVB-I =PVB/I (PVB-I)/I
A 164 100 64 1.64 0.64
B 256 150 106 1.71 0.71

PROJECTS A & B ARE BOTH ACCEPTABLE BUT PROJECT B IS BETTER