Capital Budgeting

2.3. Capital Budgeting This Section includes : Capital Budgeting Process Time Value of Money —Future Value —Present Value Investment Appraisal Techniques —Payback Period —Accounting Rate of Return —Earnings Per Share —Net Present Value —Internal Rate of Return —Net Terminal Value —Profitability Index —Discounted Payback Period Capital Rationing INTRODUCTION : Capital Budgeting is the art of finding assets that are worth more than they cost to achieve a predetermind goal i.e., ‘optimising the wealth of a business enterprise’. Capital investment involves a cash outflow in the immediate future in anticipation of returns at a future date. A capital investment decidion involves a largely irreversible commitment of resources that is generally …show more content…

5 Rate Per Annum 5.0 5.5 6.0 An amount of Rs. 15,000 invested today for 3 years will be compounded to : For instance, if the rate is 5%, then the doubling period is 69 = 0.35 + Interest Rate (ii) Rule of 69 : For a better and accurate way of calculating the doubling period : 69 = 0.35 + 13.8 = 14.15 years. 5 If compounding it done for shorter periods (i.e. other than annual compounding) = 0.35 + Fianancial Management & international finance 109 Financial Management Decisions COST-VOLUME-PROFIT ANALYSIS m×n i ⎞ ⎛ FV = PVn ⎜1 + ⎟ ⎝ m⎠ PV = i= m= n= Initial Cash Outflow Rate of interest p.a. no. of times compounding is done per year no. of years for which compounding is done. Illustration : Calculate the Future value of Rs. 1000 invested in State Bank Cash Certificate Scheme for 2 years @ 5.5% p.a., compounded semi-annully. i ⎞ ⎛ FV n = PV ⎜1 + ⎟ m⎠ ⎝ m×n = 1000 (1.0275 )4 2×2 ⎛ 0.055 ⎞ ⎟ = 1,000 ⎜1 + 2 ⎠ ⎝ = 1000 × 1.11462 = Rs. 1,114.62 Future Value of Multiple Flows Rate of Interest = 6% p.a. Total Accumulation after 3 years Being of Year 0 1 2 3 Investment (Rs.) 4,000 6,000 5,000 5,000 20,000 Total EVIF 1.2625 1.191 1.1236 1.06 Compounded Value (Rs.) 5,050 7,146 5,618 5,300 23,114 The total compounded value is Rs. 23.114 Future Value of Annuity Annuity is a term used to describe a series of periodic flows of equal amounts. These flows can be inflows or outflows. The future value of annuity is