CAPITAL

BUDGETING
MANUALS AND
PROFITABILITY

Made by
Waqar asim 50
Usman tariq 49
Atif khan 41

MEANING OF CAPITAL
BUDGETING

Capital budgeting addresses the issue of

strategic long-term investment decisions.

Capital budgeting can be defined as the

process of analyzing, evaluating, and
deciding whether resources should be
allocated to a project or not.

Process of capital budgeting ensure

optimal allocation of resources

WHY CAPITAL BUDGETING IS SO

IMPORTANT?
Involve massive investment of
resources
Are not easily reversible
Have long-term implications for
the firm
Involve uncertainty and risk for
the firm

TECHNIQUES OF CAPITAL
BUDGETING ANALYSIS

Payback Period Approach

Discounted Payback Period Approach
Net Present Value Approach
Internal Rate of Return
Profitability Index

PAYBACK PERIOD APPROACH

The amount of time needed to recover the

initial investment

The number of years it takes including a

fraction of the year to recover initial
investment is called payback period

NET PRESENT VALUE APPROACH

Based on the dollar amount of cash flows

The dollar amount of value added by a
project
NPV equals the present value of cash
inflows minus initial investment
Technique is consistent with the principle
of wealth maximizationWhy?
Accept a project if NPV 0

INTERNAL RATE OF RETURN

The rate at which the net present value of

cash flows of a project is zero, I.e., the rate
at which the present value of cash inflows
equals initial investment
Projects promised rate of return given initial
investment and cash flows
Consistent with wealth maximization
Accept a project if IRR Cost of Capital

NPV VERSUS IRR

Usually, NPV and IRR are consistent with

each other. If IRR says accept the
project, NPV will also say accept the
project
IRR can be in conflict with NPV if
Investing or Financing Decisions
Projects are mutually exclusive
Projects differ in scale of investment
Cash flow patterns of projects is different

If cash flows alternate in signproblem of

multiple IRR

If IRR and NPV conflict, use NPV approach

PROFITABILITY INDEX (PI)

A part of discounted cash flow family

PI = PV of Cash Inflows/initial investment

Accept a project if PI 1.0, which means

positive NPV

Usually, PI consistent with NPV

When in conflict with NPV, use NPV

OUR SURVEY AND DATA:

WHICH INDUSTRY USING

MANUALS

1995

2005

20

25

23 5(3)

Chemical Industry

3 1(1)

Forest industry

5 3(2)

Other companies

6 1(1)

30

38

Engineering Industry

All

2015 Non Response

37 10(7)

TYPES OF INVESTMENTS
COVERED BY THE MANUALS
Types of investments covered by manuals
Machine, land and plant

29

Some intangibles of which

14

R&D

8
Marketing Investment
Expense investment
In house Training

Leasing

7
3
1
17

Acqusations

Separate manuals for R&D

3
Acquisitions

FMS investment

PURPOSE BEHIND IT
The purpose of the capital budgeting manuals

Unity principles for evaluating and ranking

13

Financial Planning

strategic planning and control

11

create a common group language

Based on the 22 manuals ( one manual can be used for more than one purpose

Table of frequency of different profitability criteria

TABLE OF
FREQUENCY OF
DIFFERENT
PROFITABILITY
CRITERIA

Details

1995

2005

2015

Payback

79

87

100

simple payback

46

60

79

discounted payback

32

27

28

simple payback only

NA

IRR method

62

93

93

IRR method

54

53

45

IRR

50

50

45

True IRR
Capital value method

68 N.A

NPV

11

33

55

Profitability Index

14

20

21

Annuity

25

10

14

Annuity index

10

MAPI

10

11

Break Even method

No specific method

Terminal Value

ARR method

72

Note this date was collected randomly from market

CONCLUSIONS: