Page 121 - DMGT409Basic Financial Management

Basic Financial Management

Notes 2. Project Evaluation: Project Evaluation involves two steps:

(a) Estimation of benefits and costs. The benefits and costs must be measures in terms of

cash fl ows.
(b) Selection of an appropriate criterion to judge the desirability of the project.
3. Project Selection: Since capital budgeting decisions are of considerable signifi cance, the
final approval of the project may generally rest on the top management. However, projects

are screened at multiple levels.
4. Project Execution: The funds are appropriated for capital expenditure after the fi nal
selection of investment proposals. The formal planning for the appropriation of funds is
called the capital budget. The project execution committee or the management must ensure
that the funds are spent in accordance with appropriations made in the capital budget.

7.3 Methods of Capital Budgeting

There are many methods for evaluating and ranking the capital investment proposals. In all these
methods, the basic method is to compare the investments in the projects regarding the benefi ts
derived.
Figure 7.2: Techniques of Project Evaluation

Project Evaluation Techniques

Traditional Modern
or or
Non-discounted Cash Flow Discount cash Flow

Pay Back Period NPV Method

Accounting Role of Return I.R.R.

P.I. Method

1. Traditional Methods:
(a) Payback period method

(b) Accounting rate of return method
2. Discounted cash fl ow methods:
(a) The net present value of method
(b) Internal rate of return
(c) Profitability index or benefi t-cost-ratio

!

Caution It should be kept in mind that different firms may use different methods.

Which method is appropriate to a specifi c project of the fi rm, depends upon the relevant
circumstances of the proposed project under evaluation.

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