INVESTMENT IN LONG TERM PROJECTS/ FIXED ASSETS (CAPITAL BUDGETING)

2

CAPITAL BUDGETING Investment in long term projects/ Fixed

assets (Capital Budgeting)

Investment in short term assets (Working Capital Management)

3

WHAT IS A PROJECT? A task/ an undertaking, especially one

involving considerable amount of input and output. Inputs-money, labour and equipments. Output – its production

Every project has different components/ activities

Completion period is relatively long Relatively it is a large or major task

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PROJECT EVALUATION Assign value to different components/

steps of project Assessing cost and benefits of the

project All possible cost/ benefits items need to

be identified

5

COST / BENEFITS

Cost Initial

investment Working capital

investment Additional

investment

Benefits Annual revenue/

profit Salvage / scrap

value Realization of

working capital

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WHY PROJECT NEED TO BE EVALUATED Comparatively high investment Long run nature High risk Irreversible nature

7

TWO TYPES OF PROJECTS New projects

Replacement projects

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EVALUATION TECHNIQUES UNDER RISK FREE ASSUMPTION Traditional methods Pay Back Period (PBP) Average Rate of Return (ARR)

Discounting methods Net Present Value (NPV) Internal Rate of Return (IRR) Profitability Index (PI)

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DISCOUNTING Present value of future cash flows Discount by taking cost of capital Average cost of capital can be applied

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REPLACEMENT PROJECTS Incremental cash flow concept can be

applied Followings to be calculated - incremental investment - cash savings due to operating

efficiency - Tax savings due to changes of

depreciation