Capital Budgeting

In: Business and Management

Submitted By Tiane
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Capital Budgeting Techniques
Mona School of Business Financial Management Lecturer: Kathya Beckford

By the end of this session you will understand:

What capital budgeting is
How to calculate and interpret a project’s:
    


Payback Period Discounted Payback Period Net Present Value (NPV) Internal Rate of Return (IRR) Profitability Index (PI)


How to choose projects when capital is rationed

What is capital budgeting?

Capital budgeting is the process of planning expenditure on assets or projects that can have a long-term impact on an institution.

Examples of capital projects
    

Adopting a new enterprise-wide software system Launching a new advertising campaign Replacing factory equipment Expanding sales into a new market Building a road

Why is capital budgeting important?

Helps firm make smart decisions

Capital projects large and expensive- not easy to change course Allows management team to give input and be on same page

Capital budgeting techniques include:
    

Payback Period Discounted Payback Period Net Present Value (NPV) Internal Rate of Return (IRR) Profitability Index (PI)

Payback Period- The Concept
What is it? The payback period for a project is the expected time it will take to recover the original investment.
The decision rule: Accept project if its payback period is less than the maximum allowed.

Payback Period- An Example
A project requires a $100,000,000 investment and is expected to generate the following cash flows in the years after the investment is made
1 2 3 4 5

Cashflow ($)
20,000,000 40,000,000 60,000,000 30,000,000 10,000,000

What is the payback period?

Payback Period- Example cont’d
Year 1 2 3 4 5 Cashflow ($) 20,000,000 40,000,000 60,000,000 30,000,000 10,000,000 Cumulative Cashflow 20,000,000 60,000,000…...

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