An Offering At His Lotus Feet

R VIJAY SAI

Why use capital budgeting techniques

Based on idea of shareholder wealth maximization, managers use many techniques to compare returns with the expectations of the shareholders who take into account the time value of money, the risks involved in the investment process (external risks like socio political risks) and the risk of default. So investment decision is vital

Capital budgeting techniques

Pay back period
Accounting rate of return Discounted cash flow techniques
Net present value Internal rate of return

sensitivity analysis

discounted payback.

Surveys conducted over the years in India

Prasana Chandra 1975 Porwal 1976 Pandey 1989 Purohit 1994 Dhankar 1995 Babu and Sharma 1995 Jain and Kumar 1998 Manoj Anand 2002 Kashyap Soni 2006 Satish Verma, Sanjeev Gupta and Roopali Batra 2007

Phase 1
Most used methods Preferred rate of discount Risk factors considered
Pay back period Accounting rate of return(ARR)

Cost Of Capital

Chances of unavailability of inputs Probability of not achieving a target return Uncertain market potential

Methods of dealing with risk

Shorter Payback Period Higher cut off rate Conservative forecasts

Phase 2

Most used methods Preferred rate of discount Methods of dealing with risk

Gaining importance in use of DCF methods

Cost of capital Bank Rate Term Lending Rate

Sensitivity Analysis Adjusting the Discount Rate Capital Asset Pricing

Phase 3

Most used methods

DCF methods used as primary tools Traditional tools used as secondary tools

Preferred rate Weighted Average Cost of Capital of discount Marginal cost of additional funds

Sensitivity Analysis Methods of Higher cut off rate dealing with Shorter Pay Back Period risk use than project-specific risks rather than company risk in appraising new projects.

Factors Affecting Capital Budgeting decisions

Size of the firm Development of financial markets Industry Availability of funds Cost Time Education level of managers Ease of use

Gradual shift from traditional rule of the thumb methods to modern methods Acceptance of ARR has severely declined in India due to its inability to take into account the time value of money and its results taking into account non-cash items. IRR technique has been the most preferred method of capital budgeting due to ease in understanding the actual returns and the benefit of taking the time value of money into consideration. Its ability to value long gestation projects and results expressed in terms of cut-off rates may be the reason for its acceptance among Indian companies. Raising the required rate of return and sensitivity analysis are the most used risk analysis techniques used by Indian companies.

Summary

BOOKS Capital Budgeting By Anjana Bedi Corporate Finance Theory And Practice By Aswath Damodaran Financial Management By Prassana Chandra ARTICLES ASCI Journal of Management Volume 25, 1996
Capital Budgeting Practices in Indian Industry An Empirical Study By C Prabakar Babu and Aradhana Sharma Capital budget practices: A Comparative Study of India and select South East Asian Countries By U. Rao Cherukuri AN EMPIRICAL INVESTIGATION OF CAPITAL BUDGETING PRACTICES IN INDIA By Preeti Arora

REFERENCES

Internet
http://www.scribd.com/doc/79854756/Capital-Budgeting-Practices-in-Punjab http://blog-pfm.imf.org/pfmblog/files/a_review_of_capital_budgeting_practices1.pdf