**DEFINITION OF CAPITAL BUDGETING:** The process in which a business determines whether projects such as building a new plant or investing in a long-term venture are worth pursuing.In other word, capital budgeting refer to decision making process to decide whether to invest in a particular opportunities or not???

STEPS IN CAPITAL BUDGETING:

TYPES OF PROJECTS:

- Setting up new project
- Expansion Project
- Diversification Project
- Replacement and Modernization Project
- R & D Project

**DECISION RELATED TO ABOVE PROJECTS:****Mutually Exclusive Project Decision**: Acceptance of one project lead to rejection of another project. For example; Selection of one machinery out of three available machinery.**Independent Project Decision:** Acceptance of one project donot lead rejection of other that is all the project are independent of one another.**Contingent Project Decision:** Acceptance of one project is based on acceptance of another project that if one project is accepted than another project is to be accepted along with the original project.

**CAPITAL BUDGETING TECHNIQUES**: The capital budgeting techniques can be categorized in to two category as follows:

** 1. Traditional Techniques: Non- Time adjusted Method** >> Accounting Rate of Return

>> Pay back Techniques

** 2. Modern Techniques: Time adjusted Method** >> Present Value Method

>> Internal Rate of Return

>> Profitability Index

**1) Accounting Rate of Return: **

ARR = Average PAT

/Average Investment

* 100

PAT = PBDT

** - **Depreciation

** - **Taxes

Average Investment = 1

**/**2 (Original Cost of Machinery

**- **Salvaged Value)

**+** Salvaged Value

**+** Net Working capital

Deprecation: Cost of Machinery

**- **Salvaged Value

**/** Life

Average Investment:

**(**Opening Balance

**+** Closing balance

**/**2

) **+ **Working Capital

**2) Pay back period:**Initial Cash outflow

**/**Annual Cash Inflow

OR

Year reported as a full recovery

**+** unrecorded amount

**/**Cash flow during the year

3) Net Present Value Method:

Where;

Ct= Cash Inflow

Co= Cash Out Flow

r = Discounting value and Discounting rate is equal to Cost of capital

IN SIMPLE:

Present value of Cash outflow

**-** Present Value of Cash Inflow

For Example:

4) Internal Rate of Return:

Lower rate

** + (**NPV at lower rate

**/**NPV at lower rate

** - **NPV at higher rate

**) *** **(**Difference in Higher rate and Lower rate

**)**5) Profitability Index:

Cash Inflow

**/**Cash outflow

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