Financial management at
corporate finance
Explain in detail various techniques of evaluation
used in capital budgeting decision by corporate
houses.
GROUP No. -7
PRAGYA KESARWANI-(37)
PRAJJWAL-(38)
PRAMOD PAL-(39)
PRASHANT TIWARI-(40)
PRASHANT TIWARI-(41)
PRASHITA KESARWANI-(42)
The techniques and methods for evaluating capital
budgeting proposals are:
Degree of urgency method
Payback period method
Unadjusted rate of return method
Present value method
Degree of urgency method
The urgency method does not suggest any specific
evaluation method or technique; instead, it provides
suggestions about ad hoc decisions.
There are some projects or tasks that require immediate
decisions, whereas others are postponed until a future date.
An example of an urgent situation that requires an
immediate decision is the breakdown of a machine due to
the loss of a key component.
If the component is not replaced, production will suffer,
and so it will be prioritized over other projects pending
with management for approval.
The urgency method is simple to understand and use.
In essence, this is because no method is used at all; only
the decision of management is final with regard to
urgency.
Payback period method
This method is also known as the pay-off method or
replacement period method. It is a method where a
number of years are required to cover the original
investment.
This method is based on the theory that capital
expenditure pays itself back over a number of years. It
highlights the time when the original investment is
equal to the earnings generated by that investment.
Thus, the payback period is the time taken to reach the
point when the value of the original investment or outflow of
cash is equal to the inflow of cash.
The formula to calculate the payback period of an
investment is the following:
Payback period = Original investment / Annual cash inflow
The payback period can be:
(A)When even cash inflow: This means an equal amount of
income every year.
(B)(B) When uneven cash inflow: This means when cash
inflow is not uniform.
Unadjusted rate of return method
This is popularly known as the accounting rate of
return (ARR) method because accounting statements
are used to measure project profitability.
Various proposals are ranked in order of their
earnings, and the project with a higher rate of return
is selected
ARR = Average income / Average investment
There are two approaches to the unadjusted rate of return
method:
(A)Original investment method
(B) Average investment method
Original investment method
In this method, average annual earnings or profits over the life
of the project are divided by the outlay of capital cost. Thus,
ARR is the ratio between average annual profit and the original
investment. This can be expressed as follows:
ARR = Average annual profit during project lifetime / Original
investment
Average Investment Method
In this method, the average profits after depreciation
and taxes are divided by the average amount of
investment. This can be written as follows:
Average return on average investment = (Average
annual profit after depreciation and taxes / Average
investment) x 100
Present value method
The methods discussed so far lack the study of equal
weight to present and future flow of incomes.
Furthermore, these methods neglect to consider the
time value of money (i.e., that a dollar earned today
has more value than a dollar earned after five years).
By contrast, time-adjusted or discounted cash flow methods
take into account both profitability and the time value of
money. The available methods in this category are the
following:
(A)Net present value method
(B)(B) Internal rate of return method
(C) Profitability index method
THANK YOU