Page 207 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 9: Capital Budgeting
Neat Sales 85,364,213
Cost of Goods Sold 3,494,941
Selling, General & Administrative 643,706
Notes
Profit before Taxes 81,225,566
Income Taxes 602,851
Net Income 8622,715

Questions

1. Summarize the net cash flows for the proposed project.
2. For the project, calculate the internal rate of return, the accounting rate of return, the
payback period, the net present value and the profitability index.

3. What qualitative factors should be considered in evaluating this project?
4. What decision would you recommend?

9.9 Summary

 Capital budgeting describes the firm’s formal planning process for the acquisition and
investment of capital and results in a capital budget.
 Traditional Techniques to Analyze Capital budgeting decisionsTraditional Techniques of
Evaluation are Payback period, The Payback Reciprocal and Accounting Rate of Return (ARR).
 Three discounted cash flow methods used in capital budgeting are Net Present Value
Method (NPV); the Profitability Index or Desirability factor and Internal Rate of Return
(lRR).
 The net present value relies on the time value of money and the timings of cash flows in
evaluating projects.
 Internal rate of return is the interest rate that discounts an investment’s future cash flows
to the present so that the present value of cash inflows exactly equals the present value of
the cash outflows
 The process of selecting the more desirable projects among many profitable investments
is called capital rationing.
 Risk in capital budgeting is the degree of variability of cash flows.
 The conventional techniques to handle risk in capital budgeting are Payback, Risk adjusted
discount rate and Certainty equivalent method
 The application of probability distribution approach in analysing risk in capital budgeting
depends upon the behaviour of the cash flows whether the cash flows are independent or
dependent.
 The statistical techniques to quantity the risk in more precise terms are Sensitivity Analysis,
Probability assignment to expected cash flow and Standard Deviation and Co-efficient of
variation

9.10 Keywords

Break-Even Time: It is the time taken from the start of the project till the period the Cumulative
Present Value of cash inflows of a project equal to present values of the total cash outflows.
Capital Budgeting: It refers to planning and deployment of available capital for the purpose of
maximizing long-term profitability of the firm.
Capital Rationing: The allocation of the limited funds available for financing the capital projects
to only some of the profitable projects in such a manner that the long term returns are maximized.

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