Home Â» **CAPITAL BUDGETING I PRINCIPLES AND TECHNIQUES**

Internal Rate of Return (IRR) MethodÂ
Tile second discounted cash flow ([X:F) or time-adjustedÂ method for appraising capital internecine decisions is the internal rate of return (IRR) method. ThisÂ technique is also known :IS yield 01/ investment, marginal efficiency of capital, marginal productivity
of capital, rate of ‘l’IIIn!. time-adjusted rate of return and MJ 011. Like the present value method,Â

Net” Present Value (NPV) MethodÂ
11 K first DCF/I’V technique b the Â NPV Allay be described asÂ the summation of the present values of Gish proceeds (CfA i) in each year minus the summationÂ of prudent values of the net cash outflows in each year. Symbolically, the NPV for projects having
conventional l’a,h flows would be:
If cash outflow is also expected to occur at some time other than at ini

Present Value (PV) /Discounted Cash Flow (OCF)
General Procedure Â·The present value or the discounted cash flow procedure recognizes that cashÂ now streams at different time periods differ in value and can be compared only when they areÂ expressed in terms ofa common denominator ..that is, present values. It. thus, takes into accountÂ the time value of money. In this method, all cash flows arc expressed in terms o

Discounted Cash flow (DCF)/Time-Adjusted (TA) Techniques
The distinguishing characteristics or the DCF capital budgeting techniques is that they take intoÂ consideration the time value or money while evaluating the Cost sand benefits of a project, I noneÂ fond or another, all these methods require cash-flows to be discounted at a certain rate, that is, theÂ cost of capital. The cost or capital (K) is the minimum di

Evaluation
The pay hack method has certain merits. It is’ easy to calculate and simple toÂ understand. Moreover, the pay back method is an improvement over the ARR approach. ItsÂ superiority arises due to the fact that ir is based on cash now analysis. The ‘results of Example 10.6Â illustrated in Table 10.10 can be cited in support of this. Thus, though the average cash flows forÂ both the machines unde

Accept-Reject CriterionÂ
In pay hack period can be used as a decision criterion to accept orÂ reject investment proposals. One application of this technique is to compare the actual pay backÂ with a predetermined pay back, rho is, the pay hack set up’by the management in terms of theÂ maximum period during which the initial investment must be recovered. If the actual pay backÂ period is less than the predete

Pay Back MethodÂ
Computation The pay back method (PB) is the second traditional method of capital budgeting. ItÂ is the simplest and, perhaps, the most widely employed, quantitative method for appraising capitalÂ expenditure eds ions. This method answers the question: How many years will it take for the cashÂ benefits to pay the original cost of an investment, normally disregarding salvage “”ilue? R

Evaluation of ARR
In evaluating the ARR, as a criterion to’ select/reject investment projects, itsÂ merits and drawbacks need to be considered, The most favorable attribute of the ARR method isÂ its ea~y calculation. that is required is only the figure of accounting profits after taxes whichÂ would he easily obtainable. Moreover, it is simple to understand and use. In contrast to this, theÂ discounted now tec

Accept-reject RuleÂ
With the help of the ARR. the financial decision maker can decide whether toÂ accept or reject the investment proposal. As an accept-reject criterion, the actual ARR would beÂ compared with a predetermined or a minimum required rate of return or cut-off rate. A projectÂ would qualify .to be accepted if’ the actual ARR is higher than the minimum desired ARR.Â Otherwise, il is liable to be

Average Rate of ReturnÂ
Computation The average rate of return (AM) method of evaluating proposed capital expenditureÂ is also known as the accounting rate of return method. ItÂ·is based upon accounting informationÂ rather than cash flows. There is no unanimity regarding the definition of the rate of returnÂ There are a number of alternative methods for calculating the ARR.The most common usage of the
average Tate