A Summary of Capital Budgeting Techniques

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A SUMMARY OF CAPITAL BUDGETING TECHNIQUES
E A G C EDIRISINGHE - FGS/02/25/01/2012/044
COURSE MBA 61043- CORPORATE FINANCE SECOND YEAR SEMESTER ONE – 2013

Master of Business Administration
Faculty of Commerce and Management Studies University of Kelaniya

Course Instructors

:

Dr.P.M.C. Thilkarathne Dr.D.K.Y. Abeyawardena

Corporate Finance - MBA 61043

CAPITAL BUDGETING TECHNIQUES
Faced with limited sources of capital, management should carefully decide whether a particular project is economically acceptable. In the case of more than one project,

management must identify the projects that will contribute most to profits and, consequently, to the value (or wealth) of the firm. Several alternatives exist for
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The NPV method incorporates all the cash flows that a project generates over its life, not just those that occur in the project’s early years. Finally, the NPV gives a direct estimate of the change in shareholder wealth resulting from a given investment. urthermore Panday ( 999), points out that NPV is the true measure of an investment’s profitability. However according to Megginson and Smart (2008), NPVs are negative reflects the firm’s need to complete for funds in the mar etplace rather than arbitrary judgment of management and cash flows on riskier investments should be discounted at higher rates. Many managers do not trust or understand the procedure, hence prefer the PBK or ARR method because the computations are earlier.

Internal Rate of Return The IRR is similar to the NPV, which considers the time value of money. An IRR (refer equation 2.2) is the true or effective interest yield generated by an investment over its life, and can be defined as the discount rate that equates the present values of the cash outflows to equal the present values of the cash inflows (Panday, 1999).
0

(

r)
Equation 1.2

Where, R C1 = = Rate of return Single cash flow after one flow
(Source – Panday, 1999)

University of Kelaniya

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Corporate Finance - MBA 61043

It has been justified that IRR is another DCF technique which takes account of the magnitude

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