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Financial management
UNIT -6
CAPITAL BUDGETING - I
Concept of capital budgeting and its importance
+ 0
0 1 2 3 4 5 6
-
Calculation of depreciation.
Amount to be depreciated
Annual depreciation =
Life of the machinery
S.N. Year 1 2 3 4 5
1. Output 2000 2000 3000 3000 3000
(units)
2. Price (Rs.) 15 15 15 18 18
3. Revenue 30,000 30,000 45,000 54,000 54,000
(Rs.)
4. Operating 5,000 5,000 5,000 8,000 8,000
Expenses
(Rs.)
5. Depreciation 22,000 22,000 22,000 22,000 22,000
6. Profit 3,000 3,000 18,000 24,000 24,000
Before tax
(PBT)
[3-(4+5)]
7. Tax 40% 1,200 1,200 7,200 9,600 9,600
8. Profit after 1,800 1,800 10,800 14,400 14,400
tax (PAT)
(6-7)
9. CFAT 23,800 23,800 32,800 36,400 36,400
[8+5]
10. Scrap value 10,000
(7,500+8,200+7,900+8,900+6,500)/5
ARR = x 100
50,000
(39,000/5 )
= x 100
50,000
90,000
= = 18,000
5
20
7,000
ARR = x 100 = 12.72%
55,000
If we calculate ARR on the basis of initial investment
then
7,000
ARR = x 100 = 7 %
1,00,000
PAYBACK PERIOD
The Payback- period is the time duration
required to recover the initial cash outflows. This method is
based on cash flows and not on accounting data like the ARR.
Ordinary people not well versed in appraisal techniques, often
use very simple technique to judge the profitability of any
investment proposal. They think in terms of initial expenditure
(outflow) and the time duration in which this amount can be
recovered. Suppose somebody spent Rs.50,000 on any project
and expects that within 3 year he can get back this amount, then
the payback period is 3 years. Payback period of any proposal
can be calculated as follows;
DISCOUNTED PAYBACK
The concept of discounted cashflows for
calculating payback period has emerged in recent years. It is
suggested by some authors that in order to overcome the
limitation of payback that it do es not use time value of money,
we may use the discounted cashflows in order to calculate the
payback period. Obviously the discounted payback will be
longer than the simple payback period.
Illustration (6.7) A company is considering a project with an
initial outflow of Rs. 1,00,000, the cash inflows from the project
are expected to be as follows. Find out the payback period by
traditional method as well as by discounted method @ 10% rate
of discount.
Year Cash flows(Rs.)
1 20,000
2 30,000
3 30,000
4 40,000
5 30,000
6 20,000
Solution
Year Cash flows Cumulative Discounted Discounted
27
Key Words
28
Solutions
2,00,000 + 50,000 - 40,000
11. Annual Depreciation = = 35,000
6
Calculation of CFATs
Year 1 2 3 4 5 6
Output units 2,000 3,000 4,000 5,000 4,000 4,000
Price 22 22 25 25 25 30
12.
Average PAT (1,35,000/6)
ARR = x 100 = x 100
Initial Investment 2,50,000
22,500
= x 100 = 9%
2,50,000
32,000
Payback Period, =4+ = 4.54 years
59,000
33,491.51
Payback Period (discounted) = 5 + = 5.86 years
39069.88
14.
Project X Project Y
Initial Investment 50,000 60,000
Annual Depreciation 12,500 12,000
PBIT 15,000 14,000
Tax 6,000 5,600
PAT 9,000 8,400
CFAT 21,500 20,400
Payback 50,000 = 2.33 60,000 =2.94
21,500 20,400
ARR 9,000 x100 8,400 x100
25,000 30,000
= 36% = 28%