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FMCF

The document discusses various techniques used to evaluate capital budgeting proposals: 1) Degree of urgency method prioritizes projects based on immediate needs rather than evaluation. 2) Payback period method calculates the number of years to recover the initial investment. 3) Unadjusted rate of return (ARR) method ranks projects based on earnings-to-investment ratio without considering time value of money. 4) Present value method discounts future cash flows to account for time value of money and includes net present value, internal rate of return, and profitability index.

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36 views

FMCF

The document discusses various techniques used to evaluate capital budgeting proposals: 1) Degree of urgency method prioritizes projects based on immediate needs rather than evaluation. 2) Payback period method calculates the number of years to recover the initial investment. 3) Unadjusted rate of return (ARR) method ranks projects based on earnings-to-investment ratio without considering time value of money. 4) Present value method discounts future cash flows to account for time value of money and includes net present value, internal rate of return, and profitability index.

Uploaded by

prashant Tiwari
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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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

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