CT
REPOR
T ON
EVALU
ATION
OF
CAPITA
L
BUDGE
TING
Submitted By:
Itulung Kauring (13218)
Junu Dhanawat (13217)
Rajeev Taparia (13229)
Rahul Abujam (13222)
Raghav Bansal (13221)
Sanjog Choudhary (13263)
Project Report
On
Evaluation of Capital
Budgeting
[Corporate Finance]
Submitted for the partial completion of Bachelor in Management
Studies
Shaheed Sukhdev College of Business Studies
University of Delhi
Submitted By:
Itulung Kauring (13218)
Junu Dhanawat (13217)
Rajeev Taparia (13229)
Rahul Abujam (13222)
Raghav Bansal (13221)
Sanjog Choudhary (13263)
Certificate
This is to certify that the project entitled Evaluation of Capital
Budgeting, is submitted by Itulung Kauring(13218), Rahul
Abujam(13222), Rajeev Taparia(13229), Junu Dhanawat(13217),
Raghav Bansal(13221), Sanjog Choudhary(13263) of Third Semester
during the Three Years Undergraduate Programme in Bachelor in
Management Studies at Shaheed Sukhdev College of Business Studies,
University of Delhi, under the supervision of Mr. Amit Kumar during the
period of July 2014 to December 2014.
They have successfully completed the project within the stipulated
period of time.
Amit Kumar
(Project Guide)
Declaration
We hereby declare that the work presented in the project report
entitled Evaluation of Capital Budgeting, submitted for the partial
fulfilment of Bachelor in Management Studies, is an authentic record of
our own, carried out under the guidance of Mr. Amit Kumar, SSCBS, DU.
Date:
Acknowledgement
First of all, we are very thankful to Shaheed Sukhdev College of
Business Studies, University of Delhi for giving us an opportunity to
work on this project.
Through this project we have acquired invaluable knowledge about
Evaluation of Capital Budgeting through online research study and
various books.
We express our sincere thanks to our project guide Mr. Amit Kumar,
who had given us a thorough knowledge of Corporate Finance and
guided us throughout the project.
Any flaws found in this project is deeply regretted
Table of Contents
Abstract................................................................................................ 1
Objective............................................................................................... 2
Research methodology.......................................................................... 3
Introduction........................................................................................... 4
Capital budgeting principle...................................................................5
Important Concepts in Capital Budgeting...........................................6
Capital Budgeting Process..................................................................... 8
Complexity of Capital Budgeting Process............................................9
Capital Budgeting Evaluation Methods................................................10
Understanding the Project Types.......................................................10
Net Present Value (NPV)....................................................................11
Internal Rate of Return...................................................................... 11
Payback Period.................................................................................11
Profitability Index.............................................................................. 12
Selection of method.......................................................................... 12
Capital Budgeting Classification..........................................................14
Case Study: Evaluating the desirability of an investment....................16
Conclusion.......................................................................................... 18
Bibliography........................................................................................ 19
Abstract
The term Capital Budgeting refers to long term planning for proposed
capital outlay and their finance. It includes raising long-term funds and
their utilization. It may be defined as a firm's formal process of
acquisition and investment of capital. Capital budgeting may also be
defined as "The decision making process by which a firm evaluates the
purchase of major fixed assets". It involves firm's decision to invest its
current funds for addition, disposition, modification and replacement of
fixed assets. It deals exclusively with investment proposals, which is
essentially long-term projects and is concerned with the allocation of
firm's scarce financial resources among the available market
opportunities.
Some of the examples of Capital Expenditure are
Cost of acquisition of permanent assets as land and buildings.
Cost of addition, expansion, improvement or alteration in the fixed
assets.
R&D project cost, etc.
Capital budgeting is concerned with allocation of the firm's scarce
financial resources among the available market opportunities. The
consideration of investment opportunities involves the comparison of
the expected future streams of earnings from a project with immediate
and subsequent streams of expenditure for it. In any growing concern,
capital budgeting is more or less a continuous process and it is carried
out by different functional areas of management such as production,
marketing, engineering, financial management etc. all the relevant
functional departments play a crucial role in the capital budgeting
decision are considered.
The role of a finance manager in the capital budgeting basically lies in
the process of critical and in-depth analysis and evaluation of various
Objective
Research methodology
The research design of this study is descriptive in nature. This study is
based on secondary data which was obtained from various sources
online as mentioned in the bibliography of this project report. With the
help of the secondary data we have studied about the detailed
evaluation of capital budgeting, capital budgeting principle, capital
budgeting process and capital budgeting classifications. We have also
done cases study of capital budgeting, evaluating the desirability of an
investment and discussed about the factors involved in decision
making.
Introduction
In todays ever changing world, the only thing that does not change is
change itself. Successful companies are always looking at ways in
which they can change and develop. Change can trigger corporate
growth and Growth is essential for sustaining the viability, dynamism
and value enhancing capability of a company, which lead to a higher
profit and better the shareholders value. To achieve the desired
growth, the firm has to be competitive in all functional areas especially
in financial management which is the back bone of any business.
Primarily growth can be measured in terms of change in investments or
sales. A progressive business firm continually needs to expand its fixed
assets and other resources to be competitive in the race. Investment in
fixed assets is an important indicator of corporate growth. The success
of the corporate in the long run depends upon the effectiveness with
which management makes capital expenditure decisions. The finance
manager should ensure that he has explored and identified potentially
lucrative investment opportunities and proposals and select the best
one based on the opportunities identified.
In dynamic business environment, making capital budgeting
decisions are among the most important and multifaceted of all
management decisions as it represents major commitments of
companys resources and have serious consequences on the
profitability and financial stability. Evaluation need to be done for the
extent of financial stability achieved by the firms capital budgeting
decisions over a period of time. In view of this, this study has made an
attempt to know the efficiency of the corporate sectors capital
budgeting decisions.
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for all profitable projects simply by paying the required rate of return.
Capital rationing exists when the company has a fixed amount of funds
to invest If the company has more profitable projects than it has funds
for, it must allocate the funds to achieve the maximum shareholder
value subject to the funding constraints.
Payback Period
The payback period is the number of years required to recover the
original investment in a project. The payback is based on cash flows.
For example, if you invest $10 million in a project, how long will it be
until you recover the full original investment?
Payback period methods is simple and easy to understand, however, it
has many drawbacks. First, it is a measure of payback and not a
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Profitability Index
Profitability index is also called benefit/cost ratio. It is calculated as
ratio of present value of benefits of investment to cost of investment
PI = NPV (benefits) / NPV (costs)
General rule: All projects with PI > 1.0 should be accepted. Between
two or more mutually exclusive projects having different costs, we
must choose project with highest profitability index. Investment
decisions based on profitability index will be same as decisions made
using net present value. All projects having net present value have
profitability index larger than 1.0 and therefore are acceptable.
Selection of method
All 3 methods (net present value, internal rate of return, profitability
index) result in same accept-reject decision for given investment
opportunity. There are three important circumstances under which
methods may yield conflicting decisions:
1. Choosing from among mutually exclusive investment projects
with similar costs, but radically differing time patterns of cash
inflows.
Example: One project provides large cash flows in early
years and small cash flows in later years compared with
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its own private interests. Often, the company will accept the
required investment and continue to operate. Occasionally,
however, the cost of the project is sufficiently high that the
company would do better to cease operating altogether or to shut
down any part of the business that is related to the project.
Other: The projects above are all susceptible to capital budgeting
analysis, and tl1ey can be accepted or rejected using tl1e net
present value (NPV) or some other criterion. Some projects
escape such analysis. These are either pet projects of someone in
the company (such as the CEO buying a new aircraft) or so risky
that they are difficult to analyze by the usual methods (such as
some research and development decisions).
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Conclusion
Capital budgeting decision involves the exchange of current funds for
the benefit to be achieved in future. The future benefits are expected
and are to be realized over a series of years. The funds are invested in
non-flexible long-term funds. They have a long term and significant
effect on the profitability of the concern. They involve huge funds. They
are irreversible decisions. They are strategic decision associated with
high degree of risk.
Through this project we can conclude the importance of capital
budgeting as follows:
Capital budgeting decision, generally involves large investment of
funds. But the funds available with the firm are scarce and the
demand for funds for exceeds resources. Hence, it is very
important for a firm to plan and control its capital expenditure.
Capital expenditure involves not only large amount of funds but
also funds for long-term or a permanent basis. The long-term
commitment of funds increases the financial risk involved in the
investment decision.
The capital expenditure decisions are of irreversible nature. Once,
the decision for acquiring a permanent asset is taken, it becomes
very difficult to impose of these assets without incurring heavy
losses.
Capital budgeting decision has a long term and significant effect
on the profitability of a concern. Not only the present earnings of
the firm are affected by the investment in capital assets but also
the future growth and profitability of the firm depends up to the
investment decision taken today. Capital budgeting decision has
utmost has importance to avoid over or under investment in fixed
assets.
The long-term investment decision are difficult to be taken
because uncertainties of future and higher degree of risk.
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Bibliography
http://www.slideshare.net/infinite_7/case-studycapital-budgeting
http://www.investopedia.com/university/capitalbudgeting/evaluating-desirability.asp
http://www.myinvestment101.com/capital-budgeting/capitalbudgeting-evaluation-methods.html
http://www.myinvestment101.com/capital-budgeting/capitalbudgeting-principle.html
http://www.myinvestment101.com/capital-budgeting/capitalbudgeting-process.html
http://www.myinvestment101.com/capital-budgeting/capitalbugeting-classification.html