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Replacement Projects
The objective of such investments is to reduce
costs, increase yield and improve quality
Expansion Projects
These investments are meant to increase
capacity/ or widen the distribution network
Project
Classification
Diversification Projects
These investments are aimed at producing new
products or services or entering into entirely new
geographical areas
Miscellaneous Projects
Identification of Investment Proposals
Capital Budgeting
Process Fixing Priorities
Implementing Proposals
Performance Review
Methods of Capital Budgeting or
Evaluation of Investment Proposal
Average
Pay-back Net Present Internal Rate Benefit
Accounting
Period Value of Return Cost Ratio
Period
The payback period is the length of time required
to recover the initial cash outlay on the project
Dis-advantages:
It fails to consider the time value of money
It ignores cash flows beyond the payback period
• Evaluation of
Pay-Back
Administrative
Liquidity difficulties
The NPV of a project is the sum of the present Value of all cash flows-
Positive as well as Negative- that are expected to occur over the life of
the project
Properties of Net
Present Value
Intermediate Cash Flows are invested a the cost of Capital: The NPV
Rule assumes that the intermediate cash flows of a project – that is,
cash flows that occur between the initiation and the termination of
the project- are reinvested at a rate of return equal to the cost of
Capital
The NPV rule does not consider the life of the project. Hence, when
mutually exclusive projects with different lives are being considered,
the NPV is biased in favor of longer term project.
Internal Rate of Return (IRR)
The IRR of a project is the discount rate which makes its NPV equal
to Zero.
It is the discount rate which equates the present value of future cash
flows with the initial investment.
The IRR can be defined as that rate of discount at which the present
value of cash inflows is equal to the present value of cash outflows.
Example
Year 0 1 2 3 4
Cash Flows -100,000 30,000 30,000 40,000 45,000
Benefit-Cost Ratio