III Unit finance - III Unit Capital budgeting Recall the...

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III Unit Capital budgeting
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Recall the Flows of funds and decisions important to the financial manager Financial Manager Financial Markets Real Assets Financing Decision Investment Decision Returns from Investment Returns to Security Holders Reinvestment Refinancing Capital Budgeting is used to make the Investment Decision
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Capital budgeting Capital budgeting is the process of making investments in capital expenditure Capital expenditure is an outlay of funds that is expected to produce benefits over a period of time exceeding one year . ( Car, House construction etc )
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Capital Budgeting Decisions are those decisions which deal with investment in long term assets or fixed assets or capital expenditure . (long term investment decisions, capital expenditure decisions, planning capital expenditure and strategic asset allocation. etc)
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Definitions Capital budgeting is long term planning for making and financing proposed capital outlays- Charles T. Horngreen Capital budgeting as acquiring inputs with long run return– Richard Capital budgeting consists in planning of available capital for the purpose of maximizing the long term profitability of the concern. ---- Lynch
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WHERE? Acquisition Replacement Addition or expansion A truck manufacturer is considering investment in a new plant. An airliner is planning to buy a fleet of jet aircrafts A commercial bank is thinking of an ambitious computerization programme A pharmaceutical firm is evaluating a major R&D programme.
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WHY CB? CB is the process of analyzing, evaluating and deciding whether resources should be allocated to a project or not . ( expansion of MKg activity) Process of CB ensures optimal allocation of resources and helps management work towards the goal of shareholder wealth maximization.
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It is a process by which a company determines whether projects( investing in R&D, opening a new branch, replacing a machine ) are worth pursuing. A project is said to be worth when it increases the value of the company. A project ads value to the company, if it earns a rate of return that exceeds the cost of capital.
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What does it entail Involve massive investment of resources Irreversible Long term implications uncertainty and risk for the firm. National importance eg. Agrigold , Uma chit funds
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Is this a critical decision Due to the above factors capital budgeting decisions become crucial and must be evaluated very carefully Any firm that does not follow CB process will not maximize shareholder wealth and will not be acting in the best interest of shareholders. Kingfisher Airlines
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Kinds of decisions Accept – reject decisions( Min rate of return) Mutually exclusive decisions (highest return) Capital rationing decisions.(ranking based on profitability)
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Evaluation of LT investment decision It involves------ Estimation of cash flows Determining rate of discount or K o Apply the technique of capital budgeting
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Cash flow vs accounting profit
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