Capital Budgeting

DBA
Level 2 - Group 2
 Presented To
Professor: Dr. Eman Badawy
Presented By
Maha Moussa Ghorab
Neveen Abd Elaziz Lotfy
Nour Elhoda Elsayed Fawaz
Manal Ahmed Soliman Elbarbary
 01 Introduction

Agenda  Capital budgeting decision 5

02 Capital budgeting nature, purpose,

Style objective, importance, components,
process, methods, tools, problems

03 Case study
 Modern PowerPoint Presentation 36
 DEF OF Capital budgeting 19

 The purpose of capital budgeting

44
 The Objective of capital budgeting
28
 The Nature of capital budgeting
 The importance of capital budgeting
 The components of capital budgeting
 The scope of capital budgeting
 Features of capital budgeting
 The process of capital budgeting
 Factors affecting of capital budgeting
 Advantages and Limitations of capital Budgeting
 Tools of Capital Budgeting
 Methods of Capital Budgeting
 Problems in Capital Budgeting
Introduction Expansion and Growth’ are the two common goals of an
organization's operations. In case a company does not
possess enough capital, or has no fixed assets, this is
difficult to accomplish. At this point capital budgeting
becomes essential. The capital budget is used by
management to plan expenditures on fixed assets. The
purpose of capital budgeting is to make long-term
investment decisions about whether particular projects will
result in sustainable growth and provide the expected
returns.

Capital budgeting decisions tend to fall into two

broad categories:
a) Screening decisions relate to whether a proposed
project meets some preset standard of acceptance.
b) Preference decisions relate to selecting from several
competing courses of action. Preference decisions rank
alternatives in order of desirability.
Team, D. C. (2022, December 20). What is capital budgeting? process, methods, formula,
examples. Deskera Blog. https://www.deskera.com/blog/capital-budgeting/

What is Capital Budgeting?
Capital budgeting is a method
of estimating the financial
viability of capital investment
over the life of the investment.
Unlike some other types of
investment analysis, capital
budgeting focuses on cash
flows rather than profits.
Capital budgeting is the process of making investment
decisions in long-term assets. It is the process of deciding
whether or not to invest in a particular project as all the
investment possibilities may not be rewarding. Thus, the
manager has to choose a project that gives a rate of return
more than the cost of financing such a project. That is why
he has to value a project in terms of cost and benefit.
Following are the categories of projects that can be
examined using the capital budgeting process:
buy new machinery Replacement of equipment
Expansion New product or market development
 The Purposes& objectives of capital budgeting
It helps businesses:
it provides prioritize investments and allocate
a framework for evaluating financial resources more
investment opportunities and effectively.
assessing their potential risks reducing the risk of investing in
and rewards.. unprofitable projects and
maximizing returns.
Enables businesses
to plan and budget for
identify projects that
future investments,
produce cash flows that
making sure they have
exceed the cost of the
the necessary financial
project for a company.
resources to pursue them

analyzing
project's cash inflows and
outflows to determine
whether the expected
return meets a set
benchmark.
 Nature of Capital Budgeting:
1-Capital budgeting decisions involve the exchange of current funds for the benefits
to be achieved in the future.
2- The future benefits are expected to be realized over a series of years.
3-The funds are invested in non-flexible and long-term activities.
4-They have a long-term and significant effect on the profitability of the concern.
5-They involve, generally, huge funds.
6-They are irreversible decisions.
7- They are “strategic” investment decisions, involving large sums of money, a major
departure.
 Importance of capital budgeting

2-Long-Term 3-Irreversible 4-Long-Term Effect

1-Huge Investments Capital expenditure is long-term The capital investment Capital budgeting not only reduces
Capital budgeting requires huge in nature or permanent in nature decisions are irre- the cost but also increases the rev-
investments of funds, but the Therefore financial risks in- versible and are not enue in the long term and will bring
available funds are limited, volved in the investment deci- changed back. Once significant changes in the profit of
therefore, the firms before in- sion. the decision is taken for the company by avoiding over or
vesting in projects, plan to con- If higher risks are involved, it purchasing a perma- more investment or under-invest-
trol their capital expenditure. needs careful planning of capital nent asset, it is very dif- ment.
budgeting. ficult to dispose of
those assets without in-
volving huge losses.
 Scope of Capital Budgeting

01 02 03 04
Long-Term Risk & Large Funds Corporate Image
Effects Uncertainty
Capital budgeting A great deal of Any capital The profits are vitally
decisions cannot be certainty surrounds expenditure will affected by capital
changed so easily. a capital budgeting naturally involve a budgeting decisions.
Wrong decisions, decision. huge amount of These influence the
once taken, will lead Investment is the fixed market value of the
to heavy losses to the present and return commitment as shares. All accepted
firm. To take a simple is future. The future regards large projects should yield
example, suppose is uncertain and full sums of money profits leading to the
construction of a of risk. The longer making capital maximization of
premise has been the period of the budgeting an shareholder wealth.
started and the project, the greater important The image of the
management has
gone half the way.
Now, the construction
is the risk and
uncertainty. The
estimates about
exercise.
.
company will also fall
down. Capital
budgeting decisions
Scope
can’t be left hanging costs, revenues,
should improve the
in between, since the and profits may not
image of the company.
amount spent cannot come true.
be recovered.
 Features of capital budgeting
Long-term Time-sensitive
involves making long-term It takes into account the time value of
investment decisions that will affect money, which means that a dollar
your company’s financial health. today is worth more than a dollar in
. the future.

Risk-conscious Predictive
Businesses must carefully Capital budgeting requires
evaluate the potential risks and accurate financial forecasting,
rewards of each investment which involves predicting
opportunity to make informed future cash flows and
decisions. expenses.

Needs collaboration
requires collaboration and
communication among different
departments and stakeholders within
a company..
 Capital budgeting process
Step Step
Step Gathering of Decision-Making
the Investment Process in Capital
Identification
Proposals Budgeting
of Investment
Opportunities: collect investment The process of
assessing the
The process of proposals. Then the
quality and
identifying classification of the
profitability of a
potential investment is done potential investment
investment based on the different based on its
opportunities categories such as expected cash
for a expansion, flows.
company’s
replacement, welfare
capital budget.
 Capital budgeting process
Step Step 5 Step 6
Implementation
Capital Budget The process of executing and Review of Performance:
Preparations and managing approved projects.
Appropriations For the implementation at a The process of evaluating
reasonable cost and expedi- completed projects and
The process of select- monitoring their ongoing
ing the most appropri- tiously, the following things
ate investment oppor- could be helpful: – performance.
tunities based on their Formulation of the project The process of measuring
evaluation. adequately: project performance against
Techniques for Use established criteria and tak-
Ranking Projects responsibility accounting ing corrective action as
principle. needed.
such as the profitabil-
ity index and the dis- Network technique
counted payback pe- use: Several network tech-
niques like the Critical Path
riod. Method (CPM) and Program
Evaluation and Review Tech-
 Factors affecting capital budgeting Decisions
1. Risk and Uncertainty
Companies need to consider the risks associated
with the investment and the uncertainties involved
in estimating future cash flows.
2. Capital Constraints
the limitations on the amount of available capital for
investment. Companies must balance their capital
needs with their available resources, including equity,
debt, and retained earnings

5.Social and Environmental
Factors
Companies need to consider the social
and environmental impact of their
investments and factor in potential
reputational risks associated with their
investment decisions.
3. Business Environment
Companies must assess the potential impact of changes
in the business environment on their investment
opportunities and factor in the effects of these changes in
their capital budgeting decisions.
4. Government Policies
Changes in tax laws, environmental regulations, and
other government policies can significantly affect the
profitability of investment opportunities.
 Advantage& limitation of capital budgeting
Advantages:
Helps in maximizing returns: It helps in
identifying profitable investment opportunities
and maximizing returns on investments.
Ensures effective utilization of resources
by identifying the most profitable investment
opportunities.
Provides a long-term perspective while
making investment decisions, which helps in
achieving the long-term goals of the
company.
Reduces risk: By considering factors such
as risk, uncertainty, and the time value of
money
Facilitates decision-making: It provides a
structured and systematic approach for
evaluating investment proposals, which
facilitates decision-making.
Limitations
Inaccurate estimates: It relies heavily
on estimates of future cash flows and
discount rates, which may be inaccurate,
leading to incorrect investment decisions.
Ignores qualitative factors: such as
social responsibility or environmental
impact, which may be important in certain
cases.
High degree of complexity: Budgeting
techniques can be complex and time-
consuming to implement, especially for
large and complex investment projects.
Limited scope: Some techniques are
limited in scope as they only consider
financial factors and do not take into
account non-financial factors such as
reputation or brand value
 Tools for capital budgeting

Accounting Spreadsheet software: Project management Investment analysis

software: Microsoft Excel is widely soft ware software:
QuickBooks and Xero used for capital budgeting as Asana, Trello, and Prophix and Investopedia
can be used to manage it allows users to create Basecamp can be used Advisor allows users to analyze
financial data related to detailed financial models for planning and tracking investment opportunities and
capital budgeting and perform various the progress of capital assess their potential risks and
projects. calculations with ease. budgeting projects. returns
Methods of Capital Budgeting
 Traditional Method
1-Pay Back Period Methods
is the time required to recover the initial investment in a project. It is
one of the non-discounted cash flow methods of capital budgeting. If
the actual pay-back period is less than the predetermined pay-back
period, the project would be accepted. If not, it would be rejected.
Advantages:

It is easy to calculate and simple to understand.

Payback Period =
It provides further improvement over the accounting rate return.

Example It reduces the possibility of loss on account of obsolescence.

The project cost is Rs. 30,000 and the cash Disadvantages:
inflows are Rs. 10,000, and the life of the
project is 5 years. Calculate the pay-back 1-It ignores the time value of money.
period.a
𝑅𝑠. 30,000 2-It ignores all cash inflows after the pay-back period.
——————————– = 3 𝑌𝑒𝑎𝑟
𝑅𝑠. 10,000 3-It is one of the misleading evaluations of capital budgeting.
 2-Post Payback Profitability Method
One of the major limitations of the pay-back period method is that it does not
TRADITIONAL consider the cash inflows earned after a pay-back period and if the real profitability
of the project cannot be assessed. To improve this method, it can be made by
METHODS considering the receivable after the pay-back period. These returns are called
post-pay-back profits.

3-Accounting Rate of Return

means the average rate of return or profit taken for considering the project
evaluation. This method is one of the traditional methods for evaluating project
proposals. If the actual accounting rate of return is more than the predetermined
required rate of return, the project would be accepted. If not it would be rejected.
Advantages:
1-It is easy to calculate and simple to understand.
2-It is based on accounting information rather than cash inflow.
3-It is not based on the time value of money.
4-It considers the total benefits associated with the project.
Disadvantages :
1-It ignores the time value of money
2-It ignores the reinvestment potential of a project.
3-Different methods are used for accounting profit. So, it leads to
difficulties in calculation of the project.
 Modern
1- Net Present Value Method
Methods
In this method, cash inflows are
considered with the time value of the
money. It describes as the summation of
the present value of cash inflow and the
present value of cash outflow.
Net present value=the total present
value of future cash inflows - the total
present value of future cash outflows.
If the present value of cash inflows is
more than the present value of cash
outflows, it would be accepted. If not, it
would be rejected.
2-Internal Rate of Return Method
is time adjusted technique and covers the
disadvantages of the traditional techniques. In other
words, it is a rate at which discount cash flows to zero
Internal Rate of Return Method=
If the present value of the sum total of the
compounded reinvested cash flows is greater than the
present value of the outflows, the proposed project is
accepted. If not it would be rejected.
Advantages: 1-It considers the time value of money.
2-It takes into account the total cash inflow and outflow
3-It does not use the concept of the required rate of return.
4-It gives the approximate/nearest rate of return.
Disadvantages:1-It involves complicated computational methods
2-It produces multiple rates which may be confusing for taking
 3. Modified Internal Rate of Return (MIRR)
is a capital budgeting technique used to determine the rate of return on investment
by considering both the cost of the investment and the reinvestment rate of future
Modern Method cash flows.
Formula: MIRR = [(FV of positive cash flows / PV of negative cash
flows)^(1/n)] – 1
Where:
FV = Future Value PV = Present Value n = Number of periods
For example, if an investment costs $100,000 and is expected to generate
$25,000 in annual cash inflows for the next five years, with a reinvestment rate of
8%, the MIRR calculation would be as follows:
MIRR = [(54,961.35 / 100,000)^(1/5)] – 1 = 8.41%

Advantages:
1-Considers the reinvestment of future cash flows
2-Accounts for the time value of money
3-Provides a measure of the investment’s profitability
Disadvantage:
1-Requires accurate estimates of future cash flows and reinvestment rates
2-Can be complex and time-consuming to calculate
3-May not be appropriate for investments with uneven cash flows
 4. Profitability Index (PI):
The Profitability Index (PI) method technique is used to evaluate investment
opportunities by calculating the ratio of the present value of cash inflows to
the initial investment cost.
Formula: PI = PV of Expected Cash Inflows / Initial Investment
Where
PV = Present Value Initial Investment = Total cost of the investment
Expected Cash Inflows = Future cash inflows discounted to their present
value
Advantages 1-Considers the time value of money
Example: if an investment costs 2-Accounts for all expected cash inflows and outflows
$100,000 and is expected to generate 3 Provide a measure of the investment’s profitability
$25,000 in annual cash inflows for the 4-Can be used to compare multiple investment opportunities
next five years, with a discount rate of
Disadvantage
10%, the PI calculation would be as
1 may lead to incorrect decisions when evaluating mutually exclusive
follows:
projects
PI = ($18,655.94 + $16,959.04 +
2-May not always lead to the best investment decisions when budgets
$15,417.31 + $14,015.74 + $12,742.49)
are limited
/ $100,000 = 0.784
 5. Capital Rationing
Example: if a company has
$1,000,000 in available funds and
two potential investments with
total costs of $800,000 and
$1,200,000, the company would
have to choose between the two
investments based on the
availability of capital.
The capital rationing method of capital budgeting is not based on a single
formula like the other methods. Instead, it involves setting a fixed budget for
capital investments and then selecting the combination of projects that
maximizes the overall value of the firm within that budget constraint.
Therefore, the capital rationing method involves a complex decision-making
process that considers multiple factors such as project profitability, risk, and
liquidity. The decision-making process often involves using quantitative and
qualitative criteria to evaluate each project’s potential impact on the firm’s
financial performance.
Advantages
Enables a company to prioritize investments based on available funds
Helps avoid over-committing to investments
Encourages better financial management
Disadvantage:
May limit a company’s ability to pursue all profitable investments
May result in missed opportunities
Can be difficult to determine the optimal allocation of capital.
Problems in Capital Budgeting

Measurement
Time Value of Problem
Uncertainty A finance manager
Money
All capital may also face
The implications of
budgeting difficulties in
a capital budgeting
decisions measuring the cost
decision are
involve long- and benefits of a
scattered over a
term which is project in
long period..
uncertain quantitative terms.
 CASE STUDIES

Capital Budgeting Study on the Agrofood Capital

Budgeting Study on Samsung Company
 A Capital Budgeting Study on the Agrofood Company
3. Risk Assessment
agrofood must consider potential
risks. These risks may include
climatic factors, price
fluctuations, regulatory changes,
and resource availability..
Introduction:
This Case analyzing the investment opportunities
and potential risks within this sector. By conducting
a thorough analysis, we aim to provide valuable
insights to the agro food management team for
making informed investment decisions.
1. Overview of the Agrofood Industry:
The agro-food industry encompasses
various sectors such as farming,
production, processing, packaging, and
distribution of food and agricultural
products.
2. Evaluation of Investment Opportunities:
Case focuses on identifying potential
investment opportunities for the agrofood
company. It entails examining various project
options, including land cultivation, crop
diversification, technological advancements,
and sustainable farming practices.
 Financial Evaluation Techniques:
To ascertain the viability of potential investment opportunities, financial evaluation techniques such as net present
value (NPV), internal rate of return (IRR), payback period, and profitability index can be employed. These techniques
provide quantitative insights concerning the profitability and economic feasibility of each investment project.
NPV Analysis The IRR technique
calculates the rate at Sensitivity Analysis
it measures the Payback Period: It aims to evaluate how
net gain or loss which the project's
estimates the length variations in critical
generated by cash inflows equal
of time required for assumptions impact the
the investment. the cash outflows. It
an investment project project's financial
Projects with reflects the project's
to recover its initial outcomes. Factors such as
positive NPV internal rate of return
cost. Projects with market demand, input
are typically or the breakeven
shorter payback costs, and government
considered point. If the IRR
periods are generally policies may fluctuate.
financially exceeds the
preferred, as they Assessing the project's
viable, whereas company's cost of
offer a faster return sensitivity to these factors
negative NPV capital, the project is
on investment and enhances risk
projects are considered
reduced exposure to management capabilities
generally not acceptable.
risk. and decision-making
recommended. Otherwise, it may be
processes.
rejected due to
insufficient returns.
 Recommendations:
Conclusion
This case has
Agro-food Case Based on analysis, it is
demonstrated the
importance of
study recommended that the agro-
food company consider
conducting a investment projects with
comprehensive capital positive NPV and IRR
budgeting study on an exceeding the company's cost
agrofood company. of capital.
.
Which can help the
company make
informed decisions.
 Capital Budgeting Study on Samsung Company
Introduction:
This case aims to provide an in-depth analysis of the capital budgeting practices
employed by Samsung Company, a renowned multinational conglomerate
headquartered in South Korea.
Company Profile:
Samsung Company, founded in 1938, has emerged as one of the leading players in the
global electronics industry. With diverse business interests ranging from mobile devices
and consumer electronics to semiconductors and display panels, Samsung has fostered
innovation and technological advancement for decades. The company focuses on
delivering cutting-edge products to its wide consumer base worldwide.

Importance of Capital Budgeting

Capital budgeting is crucial for businesses like Samsung, as it helps them
evaluate the feasibility of potential investments and make informed decisions.
Unsound capital budgeting practices can lead to financial losses and hinder firm
growth. Therefore, it is imperative for Samsung to employ effective capital
budgeting techniques to ensure efficient resource allocation.
 Methods Used by Samsung in Capital Budgeting
NPV Analysis The IRR Payback Period: Sensitivity Analysis
This method assesses
NPV assesses technique determines how long the effect of changing
the profitability of calculates the it takes to recover the variables, such as sales
an investment by discount rate at initial investment cost. volume or production
discounting future which the NPV of Samsung uses this costs, on an
cash flows to their an investment technique to evaluate investment's profitability.
present value. becomes zero. the time it would take Samsung's usage of
Projects with This helps the to recoup their sensitivity analysis
positive NPVs are company gauge capital, providing a ensures a thorough
preferred by the profitability and measure of short- evaluation of potential
Samsung, as they efficiency of term liquidity risks associated with
yield substantial potential
investments
returns. investments.

Evaluation of Samsung's Capital Budgeting Practices:

Samsung's capital budgeting practices have proven successful, as reflected in its robust financial performance and
sustained market dominance. The company's focus on NPV and IRR allows it to make informed decisions
regarding profitable investments. Moreover, its usage of the payback period and sensitivity analysis demonstrates
a meticulous evaluation of investment risks, ensuring the optimality of resource allocation.
Conclusion:
In conclusion, Samsung's capital budgeting practices play
a pivotal role in its sustained success. Through the usage
of techniques such as NPV, IRR, payback period, and
sensitivity analysis, the company effectively evaluates
potential investments, allocates resources efficiently, and
maximizes profitability. By continuously adapting to market
dynamics and exploring emerging sectors, Samsung
continues to excel in the global electronics industry.
THANK YOU
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