Paper Topic:

The Capital Budgeting decision

Part 1

Introduction

Capital budgeting is one of the most challenging decisions for managers in the world today . It is the overall process of generating , evaluating selecting and following up on capital expenditure alternatives . In most cases , firms are affected by the amounts available for this process and the type of the proposal they are undertaking into consideration Because of this constraint , firms opt to undertake those projects which maximize their benefits in the long run . They can also rank the proposals according to the predetermined criterion and choose the best

br depending on their returns to the company . Further a company can limit its funds such that only those proposals that yield high return in the long run will be accepted whereas it can accept all the projects considered if its funds are unlimited

Net present value computation

Net present value . This method considers time value for money . It is calculated as shown below .Net present value present value of cash inflows - net investments

The criteria for accepting rejecting the project is if NPV ? 0 accept the project otherwise reject the project . The project is accepted when the NPV ? 0 because it will increase the shareholders wealth

You cannot rank project using net present value because of time value for money . The principle of time value for money states that the dollar received today is not equivalent to the dollar received tomorrow . Thus when considering projects , time value for money should be considered . In considering time value for money , the differential periods in which money is received changes in the decisions made

The projects in this case are mutually exclusive . The quantitative method that is used in this case is the net present value . It considers the cost of capital , inflation and other factors . The criterion for net present value is if the net present value is equal to or less than zero , reject the project or if it 's among many projects , accept the project with higher present value . It is calculated by the following formula The cash flows for the project are as follows Details /year 0 1 2 3 4 5

a )Initial Cost (1 ,800 ,000 ) 0 0 0 0 0

b )Depreciation tax shield

237 ,600 237 ,600 237 ,600 237 ,600 237 ,600

c )disposal of old machine 100 ,000 d )cost savings

470 ,000 470 ,000 000 ,000 470 ,000 470 ,000

Taxation (34 ,000 (159 ,800 (159 ,800 (159 ,800 (159 ,800 (159 ,800

Net cash flows (1 ,734 ,000 ) 547 ,800 547 ,800 547 ,800 547 ,800 547 ,800 NPV (1 ,734 ,000 547 ,800 547 ,800 547 ,800 547 ,800 547 ,800 (1 0 .825 )1 (1 0 .825 )2 (1 0 .825 )3 (1 0 .825 )4 (1 0 .825 )5

NPV (1 ,734 ,000 547 ,800 547 ,800 547 ,800 547 ,800 547 ,800

1 .0825 1 .1718 1 .2685 1 .3731 1 .4864

NPV (1 ,734 ,000 506 ,051 467 ,486 431 ,849 398 ,951 368 ,541...

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