Capital Budgeting: Unlocking

Growth and Success

Welcome to the world of capital budgeting, where financial decisions shape the
future of organizations, driving growth and success.

Group Members:
Aswin Preeth Babu (19)
Avi Agarwal (20)
Avinash Singh (21)
Chirag Talreja (22)
Divyanshi Ashwani Kumar Kaushal (23)
Harshvardhan Tripathi (24)
Introduction
Capital budgeting encompasses strategies and decision-making processes involved in
allocating financial resources to long-term investments. It plays a crucial role in
shaping an organization's financial future and ensuring sustainable growth.
Importance of Capital Budgeting
Enhanced Financial Decision Making
Capital budgeting provides a structured framework
that guides the allocation of financial resources,
enabling informed and strategic decision making.
Optimized Resource Allocation
By evaluating investment opportunities, capital
budgeting helps organizations direct resources
towards projects that offer the highest return on
investment.
Long-Term Impact
Effective capital budgeting takes into account long-
term goals and objectives, ensuring that investments
align with the organization's overall strategy.
Risk Mitigation
Through comprehensive analysis and assessment,
capital budgeting enables identification and
management of potential risks associated with long-
term investments.
Traditional or Non-Time adjusted Technique
Accounting or Average Rate of Return Method
(ARR)
• The average rate of return (ARR) is a financial metric used to measure the
profitability or efficiency of an investment or project. It's calculated by dividing
the average profit earned from an investment by the initial cost of the
investment.

• A higher ARR indicates a more profitable investment.

• ARR doesn't take into account the time value of money or cash flow timing,
which can be significant limitations in some financial analyses.

𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑨𝒏𝒏𝒖𝒂𝒍 𝑷𝒓𝒐𝒇𝒊𝒕

𝑨𝑹𝑹= × 𝟏𝟎𝟎
𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
Traditional or Non-Time Adjusted Technique

Payback Period Method

• The Payback Period method is a financial metric used to evaluate the time it
takes for an investment to generate enough cash flows to recover the initial cost
of the investment. It's a simple and widely used tool for assessing the risk
associated with a project or investment.

• The Payback Period method is commonly used as an initial screening tool for
investments or projects.

• The Payback Period does not consider the time value of money and It doesn't
account for the profitability or cash flows that occur after the payback period.

𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
𝑷𝒂𝒚𝒃𝒂𝒄𝒌 𝑷𝒆𝒓𝒊𝒐𝒅=
𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘
Discounted Cash Flow or Time Adjusted Technique

Net Present Value Method (NPV)

Net Present Value (NPV) is a core component of corporate finance and investment
analysis. It represents the difference between the present value of cash inflows and
the present value of cash outflows over a period of time. NPV is used to analyze the
profitability of a projected investment or project.

NPV = PV of all cash inflows – PV of all Cash outflows

Discounted Cash Flow or Time Adjusted Technique

Profitability Index Method (PI)

• The profitability index (PI) is a measure of a project's or investment's

attractiveness. The profitability index is helpful in ranking various projects
because it lets investors quantify the value created per each investment unit.

• A profitability index of 1.0 is logically the lowest acceptable measure on the

index, as any value lower than that number would indicate that the project's
present value (PV) is less than the initial investment. As the value of the
profitability index increases, so does the financial attractiveness of the proposed
project.

PV of Future Cash Flows

PI =
Initial Investment
 Discounted Cash Flow or Time Adjusted Technique

Internal Rate of Return Method (IRR)

• IRR is used in capital budgeting to rank various projects or investments and to

decide whether a specific project should be undertaken.

• IRR is a discount rate that makes the net present value (NPV) of all cash flows
equal to zero in a discounted cash flow analysis.

• When comparing investment options with other similar characteristics, the

investment with the highest IRR probably would be considered the best.

I
Challenges in Capital Budgeting
1 Uncertainty in Cash Flows
Predicting future cash flows accurately
can be challenging, as various factors such
as market fluctuations and economic
conditions impact financial projections.
2 Risk Assessment
Assessing and mitigating investment risks,
including market risks, technological
risks, and regulatory risks, require careful
analysis and evaluation.

3 Capital Rationing
When an organization faces resource constraints, capital budgeting decisions become even more
critical, as projects must be prioritized based on available funds.
Conclusion
Effective capital budgeting is a key driver of organizational success, enabling smart
financial decision making, optimizing investments, and managing risks to achieve
sustainable growth.
THANK YOU