Capital Budgeting

3643 Words Apr 13th, 2008 15 Pages
Report on Capital Budgeting

This report deals with
• The nature of capital investment appraisal
• The techniques available for evaluating capital investments
• The limitations of these techniques
• The capital budgeting practices in select countries


Some of the major responsibilities of top management are in the area of long range planning. Allocating resources to competing uses is one of the most important decisions a manager has to make. Executives are constantly faced with such questions as:

 Which projects should a firm accept?
 How should the productivity of capital be measured?
 Should the company take care of investments that reduce costs or that maintain profits or that add to
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In the extreme case, the benefits from the first may totally disappear if the second investment is accepted or it may be technically impossible to undertake both. Such investments are called mutually exclusive investments. For example, it is not possible to build one plant in two locations. Accepting one will result in automatic rejection of the other.

Techniques for Evaluating Capital Investments

Companies spend a great deal of time and money on new investments. Executives need measures of productivity of capital, which can be applied to distinguish good ones from bad ones. There are broadly two types of measures – some based on accounting income and some based on cash flows. The cash flow based measures can be further categorized as those that consider time value of money and those that don’t. Cash flow based measures that consider time value of money are called Discounted Cash Flow (DCF) techniques.

Return on Investment ROI is essentially a single period measure. Income is computed for a specified period and then divided by the average book value of assets of the same year

ROI= [EBIT (1- T) / Av. B.V of investment]
EBIT= Earnings Before Interest And Tax T= Marginal Tax Rate Av. B V= {Beginning Book value + Ending Book Value} / 2

A variant of the above formula is:

ROI = {Net Income / Average BV}

ROI computed

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