Managerial Finance

Managerial Finance

Capital Budgeting: Capital Budgeting is the process of evaluating investment projects out of which inflows are expected over a number of years to decide whether the project is acceptable or not.

There are mainly two reasons:

i. This type of investment involves huge amount of capital.

ii. The life of the project is very long.

Steps in Capital Budgeting:

i. Identifying new investment project:

ii. Estimating the cash flow (outflow & inflow)

iii. Evaluating the projects

iv. Selection & implementation

v. Continuous monitoring of the project

Application of Capital Budgeting:

i. Starting a new business

ii. Expansion of existing business

iii. Particular fixed asset

iv. Replacement of fixed asset.

v. Introduction of new production or new service.

Important Concepts:

i. Net cash outflow/Net cash outlay/initial investment/ cost of the capital

ii. Net cash inflow(NCI)/ Net cash benefit →Net profit after tax+depreciation

iii. Expected life of the project

iv. Residual value/ Salvage value

v. Discounting rate

vi. Cost of capital

vii. Opportunity cost (cost of forgoing opportunity)

Different types of investment projects/Investment decision:

i. Independent project ( Accept or Reject)

ii. Mutually exclusive

iii. Capital Rationing

1. Payback period method:

Payback period is the time required to recover (get back) net cash outflow out of net cash inflows of the project.

Example:

| Project A | Project B | Project C |

NCO | 80000 | | 80000 | | 80000 | |

NCI yr- 1 | | 20000 | | 35000 | | 25000 |

2 | | 20000 | | 45000 | | 25000 |

3 | | 20000 | | 30000 | | 20000 |

4 | | 20000 | | 20000 | | 40000 |

5 | | 20000 | | 10000 | | 50000 |

6 | | 20000 | | 8000 | | 45000 |

| 120000 | | 148000 | | 215000 |

In case of project with equal...