Вы находитесь на странице: 1из 71

Capital Budgeting

Report on Quantitave Techniques


1st Sem 2016-2017 MBA
Definition:
Capital Budgeting
1. The process of deciding whether or not to commit
resources to projects (capital investment) whose cost
and benefits are spread over several time period.
Definition:
Capital Budgeting
1. The process of deciding whether or not to commit
resources to projects (capital investment) whose cost
and benefits are spread over several time period.

- Is it worth it to put money or capital into this new


or proposed budget?
Definition:
Capital Budgeting
1. The process of deciding whether or not to commit
resources to projects (capital investment) whose cost
and benefits are spread over several time period.

- Is it worth it to put money or capital into this new


or proposed budget?
- Is it worth it to use money to buy this machine?
Definition:
Capital Budgeting
1. The process of deciding whether or not to commit
resources to projects (capital investment) whose cost
and benefits are spread over several time period.

- Is it worth it to put money or capital into this new


or proposed budget?
- Is it worth it to use money to buy this machine?
- Is it worth it to put money in this business as a
whole?
Definition:
Basic Example problem:

Lets say youre thinking of borrowing P100,000 from


the bank at 5% annual interest to buy a new machine
for P100,000. It will earn P 35,000 per year for 2 years.
However, this machine will break-down after 2 years,
but you can sell it for scrap at P50,000.
Will you win or lose money in this project?
Definition:
Capital Budgeting
1. The process of deciding whether or not to commit
resources to projects (capital investment) whose cost
and benefits are spread over several time period.
2. Is used to described actions relating to the planning and
financing capital outlays for such purposes as the
purchase of new machinery, the modernization of plant
facilities or the introduction of new product lines.
Definition:
Capital Budgeting
1. The process of deciding whether or not to commit
resources to projects (capital investment) whose cost
and benefits are spread over several time period.
2. Is used to described actions relating to the planning and
financing capital outlays for such purposes as the
purchase of new machinery, the modernization of plant
facilities or the introduction of new product lines.
3. Is an investment concept, since it involves a
commitment of funds now in order to receive some
desired return in the future in the form of additional
cash inflows or reduced cash outflows.
Types of Capital Investment:
A. New capital investment

B. Replacement or Major Repair Maintenance


Types of Capital Investment:
A. New capital investment
Examples:
a. Investment in long-term assets, such a PPE
b. New product development
c. Investment in Management Information System
d. Purchase of shares in subsidiaries or affiliates

B. Replacement or Major Repair Maintenance


Types of Capital Investment:
A. New capital investment
Examples:
a. Investment in long-term assets, such a PPE
b. New product development
c. Investment in Management Information System
d. Purchase of shares in subsidiaries or affiliates

B. Replacement or Major Repair Maintenance


Examples:
a. Replacement of old PPE
b. Overhaul of machineries
Purpose of Capital Budgeting:

Capital expenditures involve large funds, and


without proper evaluation of such action may result to
an irreversible mistake and bring significant impact
on the financial condition of the company. Therefore a
great importance is place on project selection, and the
process is called capital budgeting.
Capital Budgeting Process
1. Finding Investment Opportunities

2. Collect Relevant Information about Opportunities

3. Estimating Cash Flows

4. Evaluating Project Proposals

5. Selecting Projects

6. Implementation

7. Project Evaluation
Capital Budgeting Process
1. Finding Investment Opportunities.

A firm's sustained growth and even its ability to remain


competitive and to survive depends upon a constant flow
of ideas for new products, ways to making existing
products better and ways to produce at a lower cost. The
management, therefore, are tasked to constantly
generate project proposal for the betterment of the
company.
Capital Budgeting Process
2. Collect Relevant Information about Opportunities

a. Historical financial record of an old asset to be


replaced (Ex. Book Value and Depreciation Schedule
of the old asset)

b. Projects expected costs and benefit forecast.


Capital Budgeting Process
3. Estimating Cash Flows

Deriving accurate estimates of cashflows is the most


important and most difficult step in the entire capital
budgeting process. Estimating cash flows is important
because no step later in the process can overcome
inaccurate or unreliable information generated by this
step.

Things to know in estimating Cash Flows:


Capital Budgeting Process
Things to know in estimating cash flows:
1. Net Cash Investment or Net Investment
Cash Outflows or Cost * xxx
Less: Cash Inflows or Savings** xxx
Net Cash Investment (NCI) xxx

where:
*Cash Outflows:
1. Initial Cash outlays covering all expenditures
2. Additional working capital requirement to operate at the desired level
**Cash Inflows:
1. Trade in value of old assets (in case of replacement)
2. Proceeds from sale of old assets to be disposed due to the acquisition
of new projects (less applicable tax)
3. Avoidable cost of immediate repairs on old assets to be replaced
(net of tax)
Capital Budgeting Process
Things to know in estimating cash flows:
1. Net Cash Investment or Net Investment

Illustration:

ABC Inc. provides hot, ready-to-eat meals to construction workers. The company
is considering the purchase of a new truck to replace an old truck now in use in
delivering meals to construction sites. The new truck would cost P2M. If the new
truck is purchased, the old truck will be sold as is to another company for
P400,000. This old truck was acquired for P1.2M and has a current book value of
P500,000. If the new truck is not purchased, the company will have to continue
using the old one, although extensive repairs would be needed that will cost
P250,000. This repairs cost will be expensed, for tax purposes, in the year
incurred. The income Tax rate for corporations is 32%. If the new truck is
purchased, the net cost of investment for decision-making purposes is?
Capital Budgeting Process
Solution:
1. Net Cash Investment or Net Investment
Cash Outflows:

Less: Cash Inflows:

Net Cash Investment


Capital Budgeting Process
Solution:
1. Net Cash Investment or Net Investment
Cash Outflows:
Purchase cost of new truck P 2,000,000
Additional working capital 0
Total Cash Outflows 2,000,000
Less: Cash Inflows:

Net Cash Investment


Capital Budgeting Process
Solution:
1. Net Cash Investment or Net Investment
Cash Outflows:
Purchase cost of new truck P 2,000,000
Additional working capital 0
Total Cash Outflows 2,000,000
Less: Cash Inflows:
Sales proceed P 400,000
Tax savings due to loss on sale
Sales proceed P400,000
Book Value 500,000
Loss -100,000
x Tax Rate 32% 32,000
Avoidable cost of repairs
(P250,000 x 68%) 170,000 602,000
Net Cash Investment P 1,398,000
Capital Budgeting Process
Things to know in estimating cash flows:
2. Cost of Capital (COC)
Cost of using fund (weighted average cost of debt and Equity capital used). Also
called hurdle rate, required rate of return, cut-off rate.

Weighted Average Cost of Capital (WACC)


LT Debt (Debt Ratio x Cost of Debt) xxx
Preferred Stock (PS Ratio x Cost of PS) xxx
Common Stock (CS Ratio x Cost of CS) xxx
WACC xxx
Note: COC is a separate topic and all sample computations will not be discussed.
All COCs will be just provided in the sample problems.

3. Net Returns
Refers to the accounting net income or annual net cash inflows (ANCI). This
return should be AFTER TAX cash inflows. Refer to the next slide for illustration.
Capital Budgeting Process
Things to know in estimating cash flows:
Net Returns / ANCI
Illustration:
A company is investigating the possibility of acquiring a machine that will cost
P12,000 and will have annual depreciation for tax purposes of P2,400 for 5years.
The machine is expected to result in a cash saving from operations of P4,000 per
year. If the tax rate is 30%, what is the annual net cash inflows?

Solution:
Capital Budgeting Process
Things to know in estimating cash flows:
Net Returns or ANCI
Illustration:
A company is investigating the possibility of acquiring a machine that will cost
P12,000 and will have annual depreciation for tax purposes of P2,400 for 5years.
The machine is expected to result in a cash saving from operations of P4,000 per
year. If the tax rate is 30%, what is the annual net cash inflows?

Solution:
Method 1
Net Cash Savings P 4,000
Less: Depreciation 2,400
Earnings Before Tax (EBT) 1,600
Less: Tax (30%xP1,600) 480
Earnings After Tax (EAT) 1,120
Add back: Depreciation 2,400
ANCI 3,520
Capital Budgeting Process
Things to know in estimating cash flows:
Net Returns / ANCI
Illustration:
A company is investigating the possibility of acquiring a machine that will cost
P12,000 and will have annual depreciation for tax purposes of P2,400 for 5years.
The machine is expected to result in a cash saving from operations of P4,000 per
year. If the tax rate is 30%, what is the annual net cash inflows?

Solution:
Method 1 Method 2
Net Cash Savings P 4,000 P 4,000
Less: Depreciation 2,400
Earnings Before Tax (EBT) 1,600
Less: Tax (30%xP1,600) 480 480
Earnings After Tax (EAT) 1,120
Add back: Depreciation 2,400
ANCI 3,520 3,520
Capital Budgeting Process
4. Evaluating Project Proposals

Before arriving on a capital expenditure decision, some


techniques or methods of evaluating capital investment
projects should be first considered.
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money

b. Discounted cash flows Methods that consider time


value of money
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period)
2. Bail-out Period
3. Accounting Rate of Return (Book Value Rate of
Return)
b. Discounted cash flows Methods that consider time
value of money
1. Net Present Value
2. Internal Rate of Return (Discounted Rate of Return)
3. Profitability Index
4. Discounted Payback Period
Capital Budgeting Process
1. Payback period (also known as Payoff and Payout
Period)
-measures the length of time required to recover
the amount of initial investment. It is the time
interval between time of the initial outlay and the full
recovery of the investment. How soon will the
investment of the project be recovered?
Capital Budgeting Process
Techniques to solve Payback Period:

a. Know and understand the Net Investment or NCI (Discussed already)


b. Know and understand the ANCI (Discussed already)
c. When the periodic ANCI is uniform/even over the estimated useful life,
simply use this formula:

Payback Period = Net Investment (NCI)


ANCI
Illustration:
Net Investment in Equipment P150,000
Estimated Useful of the Equipment 5 years
Annual Net Cash Inflows for 5 years 75,000

Solution:
Capital Budgeting Process
Techniques to solve Payback Period:

a. Know and understand the Net Investment or NCI (Discussed already)


b. Know and understand the ANCI (Discussed already)
c. When the periodic ANCI are uniform/even over the estimated useful life,
simply use this formula:

Payback Period = Net Investment (NCI)


ANCI
Illustration:
Net Investment in Equipment P150,000
Estimated Useful of the Equipment 5 years
Annual Net Cash Inflows for 5 years 75,000

Solution:

Payback Period = Net Investment (NCI) = P150,000 = 2 years


ANCI 75,000
Capital Budgeting Process
Techniques to solve Payback Period:

d. When the ANCI are not uniform


Payback is computed by accumulating the estimated ANCI and determining
the point in time at which they equal the investment outlay.

Illustration:
Net Investment in Equipment P300,000
Estimated Useful of the Equipment 5 years
Annual Net Cash Inflows
Years 1 3 75,000
Years 4 5 100,000
Capital Budgeting Process
Techniques to solve Payback Period:

Illustration:
Net Investment in Equipment P300,000
Estimated Useful of the Equipment 5 years
Annual Net Cash Inflows
Years 1 3 75,000
Years 4 5 100,000

Solution:
NCI P300,000
Less: ANCI
Years 1 3 (P75,000 x 3) P225,000
Year 4, balance to full recovery 75,000 300,000
Therefore the payback is 3 year + fraction of:
(Fraction = P75,000 / P100,000) = 3.75 years
Capital Budgeting Process
Payback period (also known as Payoff and Payout Period)

Decision Rule:
The desirability of the project is determined by comparing the projects payback
period against the maximum acceptable payback period as predetermined by the
management.

If PB = < Maximum allowed PB period , Accept


If PB > Maximum allowed PB period, Reject

Advantages:
1. It is easy to compute
2. It is used to measure the degree of risk associated with a project.
3. Generally, the longer the payback period, the higher the risk.
4. It is used to select projects which provide a quick return of invested funds.
Disadvantages:
1. It does not recognized time value of money
2. It ignores the impact of cash inflows after the payback period.
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period) DONE
2. Bail-out Period
3. Accounting Rate of Return (ARR)
b. Discounted cash flows Methods that consider time
value of money
1. Net Present Value
2. Internal Rate of Return (Discounted Rate of Return)
3. Profitability Index
4. Discounted Payback Period
Capital Budgeting Process
2. Bail-out period (also known as Payoff and Payout
Period)
-measures the length of time required to recover
the amount of initial investment considering the
salvage value.
Capital Budgeting Process
Techniques to solve Bail-out Period:

a. Know and understand the Net Investment or NCI (Discussed already)


b. Know the Salvage Value
c. Know and understand the ANCI (Discussed already)
d. Test the ANCI by accumulating it plus the current SV of each period.
Capital Budgeting Process
Techniques to solve Bail-out Period:

Problem 1 (Bail-out):
Energy company is planning to spend P84,000 for a new machine, to be
depreciated on the straight-line basis over 10years. The related cash flow from
operations, net of income taxes, is expected to be P10,000 a year for each of the
first 6years and P12,000 for each of the next 4years. In addition, Energy
Company has also estimated the salvage value of the new machine at the end of
year 1 to be P64,000. Salvage Value will decline by P5,000 each thereafter. What
is bailout payback period?

Solution:
Capital Budgeting Process
Techniques to solve Bail-out Period:

Problem 1 (Bail-out):
Energy company is planning to spend P84,000 for a new machine, to be
depreciated on the straight-line basis over 10years. The related cash flow from
operations, net of income taxes, is expected to be P10,000 a year for each of the
first 6years and P12,000 for each of the next 4years. In addition, Energy
Company has also estimated the salvage value of the new machine at the end of
year 1 to be P64,000. Salvage Value will decline by P5,000 each thereafter. What
is bailout payback period?

Solution:
Investment 84,000.00
Test: Cumulative ANCI + Current SV of each period YEAR
1st yr (10,000 + 64,000) 74,000.00 X 1
2nd yr (20,000 + 59,000) 79,000.00 X 2
3rd yr (30,000 + 54,000) 84,000.00 STOP 3
Therefore, bail-out period is 3years
Capital Budgeting Process
Techniques to solve Bail-out Period:

Problem 2 (Bail-out):
An investment of P180,000 is expected to produce annual cash earnings of
P50,000 for 5 years. Its estimated salvage value is P70,000 during the first year
and this is expected to decrease by P15,000 annually. What is the bailout
payback period?

Solution:
Capital Budgeting Process
Techniques to solve Bail-out Period:

Problem 2 (Bail-out):
An investment of P180,000 is expected to produce annual cash earnings of
P50,000 for 5 years. Its estimated salvage value is P70,000 during the first year
and this is expected to decrease by P15,000 annually. What is the bailout
payback period?

Solution:
Investment 180,000.00
Test: Cumulative ANCI + Current SV of each period YEAR
1st yr (50,000 + 70,000) 120,000.00 X 1
2nd yr (100,000 + 55,000) 155,000.00 X 1
3rd yr (150,000 + 40,000)190,000.00 180,000.00 STOP 0.8

Therefore, bail-out period is 2years + fraction of 0.80 = 2.80 years


Fraction = (180,000 - 140,000*) / 50,000** = 0.80
where: 180,000 = Net Investment
*Accumulated ANCI before you stop + Next SV period = 100,000 + 40,000
**ANCI, unaccumulated = 50,000
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period) DONE
2. Bail-out Period DONE
3. Accounting Rate of Return (ARR)
b. Discounted cash flows Methods that consider time
value of money
1. Net Present Value
2. Internal Rate of Return (Discounted Rate of Return)
3. Profitability Index
4. Discounted Payback Period
Capital Budgeting Process
3. Accounting Rate of Return (ARR, or Book Value Rate
of Return or Simple Rate of Return)
-measures profitability from the conventional
accounting standpoint by relating the required
investment to the future annual net income.

AAR = ANCI- Depreciation


Initial Investment
Capital Budgeting Process
Problem (ARR):
Consider the following information about a proposed project:
Initial Investment Required P 65,000
Estimated Useful Life 20 years
Annual Net Cash Inflows (ANCI) P10,000
Salvage value of the asset at the end of 20 years 0
Straight-line method of depreciation will be used.

Required: Compute ARR

Solution:
Capital Budgeting Process
Problem (ARR):
Consider the following information about a proposed project:
Initial Investment Required P 65,000
Estimated Useful Life 20 years
Annual Net Cash Inflows (ANCI) P10,000
Salvage value of the asset at the end of 20 years 0
Straight-line method of depreciation will be used.

Required: Compute ARR

Solution:

ARR = ANCI Depreciation = P10,000 P3,250* = 10.38%


Initial Investment P65,000

*Depreciation = P65,000 / 20 years = P3,250


Capital Budgeting Process
ARR Decision Rule:
Under the ARR method, choose the project with the highest rate of return. Accept
the project if the ARR is greater than the cost of capital or required rate of
return. Thus:

If ARR = > Required Rate of Return; Accept


If ARR < Required Rate of Return; Reject

Advantages:
1. It is easily understood by investors acquainted with financial statements.
2. It is used as a rough preliminary screening device of investment proposals.

Disadvantages:
1. It does not recognized time value of money.
2. It does not consider the timing component of cash inflows.
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period) DONE
2. Bail-out Period DONE
3. Accounting Rate of Return (ARR) DONE

b. Discounted cash flows Methods that consider time


value of money
1. Net Present Value
2. Internal Rate of Return (Discounted Rate of Return)
3. Profitability Index
4. Discounted Payback Period
Capital Budgeting Process
b. Discounted cash flows Methods that consider time value of money. Cash
outlays and Cash Inflows are both discounted back to the present period using
appropriate discount rate.

Advantages:
1. It is more reliable because the time value of money is taken into account.
2. Income over the entire life of the project is considered.
3. It is more objective and relevant because if focuses on cashflows.

Disadvantages:
1. It is not easily understood.
2. It is more complex and difficult to apply.
3. It requires detailed long-term forecasts of incremental cash flow data.
4. It requires pre-determination of the cost of capital or the discount rate to be
used.
Capital Budgeting Process
b. Methods of Discounted cashflow techniques
1. Net Present Value (NPV)
The excess of the present value (PV) of cash inflows
generated by the project over the amount of the
initial investment
Types of PV
a. PV of P1 = Yearly PV
b. PV of an Annuity of P1 = Accumulated PV
Note: Computation of PV is not discussed here. PV is provided in the
problem.

Total Present Value of After-Tax Cash Flow xxx


Less: Investment xxx
Net Present Value (NPV) xxx
Capital Budgeting Process
Problem 1 (NPV Uniform ATCF)
Assumed a certain company has an option to invest on a certain equipment
costing P600,000 to be depreciated 5 years annually. Such investment will give
the company an annual savings of P168,000 after tax. In order to buy such
equipment, the company needs to loan in a bank with an annual interest of 14%
for 5 years.
PV of an Annuity, 14% at 5 years = 3.4331
PV of P1, 14%, 5th year = 0.519367
Compute the Net Present Value of the investment.

Solution:
Capital Budgeting Process
Problem 1 (NPV Uniform ATCF)
Assumed a certain company has an option to invest on a certain equipment
costing P600,000 to be depreciated 5 years annually. Such investment will give
the company an annual savings of P168,000 after tax. In order to buy such
equipment, the company needs to loan in a bank with an annual interest of 14%
for 5 years.
PV of an Annuity, 14% at 5 years = 3.4331
PV of P1, 14%, 5th year = 0.519367
Compute the Net Present Value of the investment.

Solution:
PV of ATCF (P168,000 x 3.4331) P576,761
Less: Investment 600,000
NPV - 23,239
Capital Budgeting Process
Problem 2 (NPV Uneven ATCF)
JP Corp. plans to invest in a 4-year project that will cost P750,000. JPs cost of
capital is 8%. Additional information on the project is as follows:
Year ATCF PV of P1, 8%
1 P200,000 0.926
2 220,000 0.857
3 240,000 0.794
4 260,000 0.735
Required: Using the NPV method, determine whether the project is acceptable or
not.

Solution:
Capital Budgeting Process
Problem 2 (NPV Uneven ATCF)
JP Corp. plans to invest in a 4-year project that will cost P750,000. JPs cost of
capital is 8%. Additional information on the project is as follows:
Year ATCF PV of P1, 8%
1 P200,000 0.926
2 220,000 0.857
3 240,000 0.794
4 260,000 0.735
Required: Using the NPV method, determine whether the project is acceptable or
not.

Solution:
PV of ATCF 1 (P200,000 x 0.926) P185,200
2 (P220,000 x 0.857) 188,540
3 (P240,000 x 0.794) 190,560
4 (P260,000 x 0.735) 191,100
Total PV of ATCF P755,400
Less: Investment 750,000
NPV P 5,400
Capital Budgeting Process
NPV Decision Rule:
For independent project proposal, accept it if NPV is positive or zero and reject if
NPV is negative. If the NPV is positive, it means that the project will earn a
return greater than the discount rate also known as hurdle rate. Thus:

If NPV = > 0; Accept


If NPV < 0; Reject

Going back to the Problems of NPV, decide (accept or reject):


1. Problem 1 NPV = -P 23,239
2. Problem 2 NPV = P 5,400
Capital Budgeting Process
NPV Decision Rule:
For independent project proposal, accept it if NPV is positive or zero and reject if
NPV is negative. If the NPV is positive, it means that the project will earn a
return greater than the discount rate also known as hurdle rate. Thus:

If NPV = > 0; Accept


If NPV < 0; Reject

Going back to the Problems of NPV, decide (accept or reject):


1. Problem 1 NPV = -P 23,239 REJECT
2. Problem 2 NPV = P 5,400 ACCEPT
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period) DONE
2. Bail-out Period DONE
3. Accounting Rate of Return (ARR) DONE

b. Discounted cash flows Methods that consider time


value of money
1. Net Present Value DONE
2. Internal Rate of Return (IRR)
3. Profitability Index
4. Discounted Payback Period
Capital Budgeting Process
2. Internal Rate of Return (Discounted Rate of Return)
-The rate which equate the present value of the
future cash inflows with the cost of the investment
which produces them.

IRR = NPV, therefore NPV = 0

Problems can be solve using interpolation method or


intelligent guess, where the objective is to equate
IRR to NPV. Knowledge in PV computations are highly
recommended in this subject. A lengthy and separate
lecture is needed to discuss the interpolation.
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period) DONE
2. Bail-out Period DONE
3. Accounting Rate of Return (ARR) DONE

b. Discounted cash flows Methods that consider time


value of money
1. Net Present Value DONE
2. Internal Rate of Return (IRR) DONE
3. Profitability Index
4. Discounted Payback Period
Capital Budgeting Process
3. Probability Index
-The Probability Index, (also known as present value
index, benefit cost rate, desirability index), is the
ratio of the total present value of future cash inflows
to the initial investment.

PI = PV of Cash Inflows
PV of Net Investment
Capital Budgeting Process
Problem 1 (PI)

Company XYZ has P200,000 funds available for investment. It is considering the
following projects:
A B C
PV of ATCF P244,000 P130,000 P130,000
Less: Investment 200,000 100,000 100,000
NPV P 44,000 P 30 ,000 P 30,000

Required: Compute the profitability index of each project. Which project/s should
be undertaken?

Solution:
Capital Budgeting Process
Problem 1 (PI)

Company XYZ has P200,000 funds available for investment. It is considering the
following projects:
A B C
PV of ATCF P244,000 P130,000 P130,000
Less: Investment 200,000 100,000 100,000
NPV P 44,000 P 30 ,000 P 30,000

Required: Compute the profitability index of each project. Which project/s should
be undertaken?

Solution:
Project A PI = P244,000/P44,000 = 1.22
Project B PI = P130,000 / P30,000 = 1.30
Project C PI = P130,000 / P30,000 = 1.30
The company should invest in Projects B and C, since their PV indexes are the
highest. The company can afford to invest in both A and B.
Capital Budgeting Process
PI Decision Rule:
The higher the profitability index, the more desirable the project. Projects with
index of less than 1 are rejected.

If PI = > 1; Accept
If PI < 1; Reject
Capital Budgeting Process
Methods of Evaluating Capital Investment Projects:
a. Non-discounted cash flow - Methods that do not
consider time value of money
1. Payback period (Payoff and Payout Period) DONE
2. Bail-out Period DONE
3. Accounting Rate of Return (ARR) DONE

b. Discounted cash flows Methods that consider time


value of money
1. Net Present Value DONE
2. Internal Rate of Return (IRR) DONE
3. Profitability Index DONE
4. Discounted Payback Period
Capital Budgeting Process
4. Discounted Payback Period
-This is used to compute the payback in terms of
discounted cash flows received in the future. That is,
the periodic cash flows are discounted using an
appropriate cost of capital rate.
Capital Budgeting Process
Problem 1 (Discounted Payback Period)
A project requiring an investment of P70,000 is expected to generate the
following cash inflows:
Year Amount PV of P1, 15%
1 P60,000 0.870
2 60,000 0.756
3 60,000 0.658
4 60,000 0.572
5 60,000 0.497
Required: What is its discounted payback period?

Solution:
Capital Budgeting Process
Problem 1 (Discounted Payback Period)
A project requiring an investment of P70,000 is expected to generate the
following cash inflows:
Year Amount PV of P1, 15%
1 P60,000 0.870
2 60,000 0.756
3 60,000 0.658
4 60,000 0.572
5 60,000 0.497
Required: What is its discounted payback period?

Solution:
Year Cash Inflows Discounted Cash Flow Balance
0 P(170,000) P(170,000) P(170,000)
1 60,000 (60,000 x 0.870) 52,000 (118,000)
2 60,000 (60,000 x 0.756) 45,000 ( 73,000)
3 60,000 (60,000 x 0.658) 39,000 ( 34,000)
4 60,000 (60,000 x 0.572) 34,000 0
The discounted payback period is 4years.
Capital Budgeting Process
1. Finding Investment Opportunities

2. Collect Relevant Information about Opportunities

3. Estimating Cash Flows

4. Evaluating Project Proposals

5. Selecting Projects

6. Implementation

7. Project Evaluation
Capital Budgeting Process
5. Selecting Projects (Decision)

Based on the methods of evaluating the capital


expenditures, we decide whether we accept or reject the
project proposal.
Capital Budgeting Process
6. Project Implementation

Once the decision has been made to invest funds, more


detailed plans for making the project operational are
developed.
Capital Budgeting Process
7. Project Evaluation and Appraisal

This last phase involves the assessment of how effective


the investment actually is. The evaluation may be in the
form of continuous monitoring of the project, so that
corrective action can be taken.
Capital Budgeting Process

Thank you for listening

Вам также может понравиться