FINANCIAL

MANAGEMENT
CAPITAL BUDGETING [ NPV and PI ]

PRESENTED BY :-

PRESENTED TO:- Abhishek Agarwal {2}

Dr. Shivani Sharma Prabal Parashar {39}
Rounak Goreja {44}
Sejal Gupta {50}

1
CAPITAL BUDGETING

Capital budgeting is the process a business undertakes to evaluate potential major projects or
investments. 

 Capital budgeting is used by companies to evaluate major projects and investments, such as new
plants or equipment. 

 The process involves analyzing a project’s cash inflows and outflows to determine whether the
expected return meets a set benchmark.  

 The major methods of capital budgeting include discounted cash flow, payback, and throughput
analyses.
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OBJECTIVES OF
CAPITAL BUDGETING

• An organization comes across various profitable projects frequently. But

Selecting  Profitable due to capital restrictions, an organization needs to select the right mix of
Projects profitable projects that will increase its shareholders’ wealth.  

Capital Expenditure • Selecting the most profitable investment is the main objective of capital
budgeting. However, controlling capital costs is also an important
Control objective.

• Determining the quantum of funds and the sources for procuring them is
Finding The Right another important objective of capital budgeting.
Sources for Funds
“
Net Present Value Method

 Net Present Value Method- Discounted cash flow technique that explicitly that recognizes the
time value of money.

 It correctly postulates that cash flows arising at different time periods differ in value are
comparable only when their equivalents present values are found out.

 Net present value (NPV) is the difference between the present value of cash inflows and the
present value of cash outflows over a period of time. It may be positive, zero or negative.

 NPV is used in capital budgeting and investment planning to analyze the profitability of a
projected investment or project.

 It accounts for time value of money by using discounted cash flows in the calculation.
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THREE POSSIBILITIES

Positive • If present value of cash inflows is greater than the

present value of the cash outflows, the net present

NPV value is said to be positive and the investment

proposal is considered to be acceptable.

Negative • If present value of cash inflow is less than present

value of cash outflow, the net present value is said to

NPV be negative and the investment proposal is rejected.

• If present value of cash inflow is equal to present

Zero NPV value of cash outflow, the net present value is said
to be zero and the investment proposal is considered
to be acceptable.
“
Decision Rule 

 Accept the project only if its NPV is positive or zero.

 Reject the project having negative NPV.

 While comparing two or more exclusive projects having positive NPVs,

accept the one with highest NPV.

Formula

NPV = (PRESENT VALUE OF CIF – PRESENT VALUE OF

COF)
PV Factor = 1/(1+r)t
Where,
R= Discount rate
T= Number of time period
Profitability Index

 Profitability Index (PI) is a capital budgeting technique to evaluate the investment projects for
their profitability. Discounted cash flow technique is used in arriving at the profitability index. It
is also known as benefit-cost ratio.

 Calculation of profitability index is possible with a simple formula with inputs as – discount rate,
cash inflows and outflows. PI greater than or equal to 1 is interpreted as good and is acceptable.

 Profitability Index is a ratio of discounted cash inflow to the discounted cash outflow. Discounted
cash inflow is our benefit in the project and the initial investment is our cost, which is why we
also call it benefit to cost ratio
Decision Rule

Accept a project if the profitability index is greater than 1, stay indifferent if the
profitability index is one and don't accept a project if the profitability index is below 1.

Formula

PRESENT VALUE OF CIF

PRESENT VALULE OF COF

NUMERICAL

 A project cost is Rs. 10,000 and it generates cash inflows of Rs. 1000;
3000; 4000; 6000; and 2000 throughout the period of 5 years. The required
rate of return is assumed to be 10%. Find out the NPV and PI of the
project.
SOLUTION:
FR
YEARS [C.I.F] CASH IN FLOW PRESENT VALUE @10% PRESENT VALUE OF C.I.F.
IN Rs.
1 1000 0.909 909
2 3000 0.826 2478
3 4000 0.751 3004
4 6000 0.683 4098
5 2000 0.621 1242
TOTAL P.V OF C.I.F.=11731

 NPV =PRESENT VALUE OF CIF–PRESENT VALUE OF COF

NPV =11731-10000
NPV =Rs.1731

 PI=PRESENT VALUE OF CIF/PRESENT VALUE OF COF

PI=11731/10000
PI=1.17 TIMES
Annual Review 11
. THANK YOU .