G H Raisoni College Of

Engineering And
Management , Wagholi ,
Pune
Subject : Financial Management for
Engineers
Unit III : Capital Budgeting
By
Sweta Khandekar
 Vision of Institute

To achieve excellent standards of quality education by keeping

pace with rapidly changing technologies and to create technical
manpower of global standards with capabilities of accepting new
challenges.

Mission of Institute

Our efforts are dedicated to impart quality and value based

education to raise satisfaction level of all stake-holders. Our
strength is directed to create competent professionals. Our
endeavor is to provide all possible support to promote research
and development activities.

2
Teaching Credit Examinatio
Scheme n Scheme
TH: 02Hours/Week 02 TAE: 10 Marks
CAE: 10 Marks
ESE: 30 Marks

3
 Syllabus
Uni Unit Name Syllabus No Of
t Lecture
No require
d
I Introduction Level of Knowledge: Conceptual: 06
Financial Management: Meaning, nature and
scope of finance; financial goal - profit vs. wealth
maximization; Investment, Financing and Dividend
decisions - Finance functions – organization
structure – functions of finance manager in 21st
century – Modern role -  treasurer and controller.
Emerging role of finance managers – Sources of
long term finance.
II Financial Level of Knowledge: Analytical 06
Planning Objectives, Benefits, Guidelines, Steps in Financial
Planning, Factors Affecting Financial Planning,
Estimation of Financial Requirements of a Firm,
Capitalization, Time Value of Money: 

4
 Syllabus
Unit Unit Name Syllabus No Of
No Lecture
require
d
III Capital Level of Knowledge: Analytical 06
Budgeting  Capital Budgeting: Nature of investment
decisions; Investment evaluation criteria - net
present value, internal rate of return, profitability
index, payback period, accounting rate of return:
NPV and IRR comparison; Capital rationing; Risk
analysis in capital budgeting.
IV Cost of Capital Cost of Capital: Meaning and significance of cost of 06
capital: Calculation of cost of debt, preference capital,
equity capital and retained earnings; Combined cost of
capital (weighted); Cost of equity and CAPM; Leverages:
Meaning and types of leverages in business – Financial
leverage and its impact on EPS – Operating leverage –
combined leverage – degree of leverages – working
capital leverages – practical use of leverages

5
 Course Outcomes
1. Introduce to the fundamentals of financial management
2. Familiarize students with cost of capital
3. Capital structure and capital budgeting, techniques to
support for managerial decisions
4. Acquaint students with corporate financial modeling and
financial management of sick unit

6
 Budgeting
• Budgeting is a management tool for planning
and controlling future activity.
Financial Buzz Woids: A plan for saving,
borrowing and spending.
• Budget is a financial plan and a list of all
planned expenses and revenues.
• Budgeting defined by the "Rowland and
William" it may be said to be the art of building
budgets. • Budgets are blue print of a plan and
action expressed in quantities and manners.
7
 Capital Budgeting
Capital: Operating assets used for production.
The word Capital refers to be the total
investment of a company in tangible and
intangible assets.
Budget: A plan that details projected cash
flows during some period.
Capital Budgeting: Process of analyzing
projects and deciding which ones to include
in capital budget.

8
 Capital Budgeting
• Capital budgeting is a long term planning exercise in
selection of the projects which generates returns over a
number of years in future and the heavy expenditure is
to be incurred in the initial years of the project to
generate returns over the life of the project. Therefore,
this includes the investment decision.
• Investment decision/ capital budgeting decision is a
decision concerned with allocation of funds to get proper
yield from project. So that it can recover the cost
associated with each source of fund and earn required
amount of profit to compensate the risk involved in the
business.

9
 Need and Importance of Capital
Budgeting
1. Huge investments: Capital budgeting requires huge investments
of funds, but the available funds are limited, therefore the firm
before investing projects, plan are control its capital expenditure.

2. Long-term: Capital expenditure is long-term in nature or

permanent in nature. Therefore financial risks involved in the
investment decision are more. If higher risks are involved, it
needs careful planning of capital budgeting.

3. Irreversible: The capital investment decisions are irreversible,

are not changed back. Once the decision is taken for purchasing
a permanent asset, it is very difficult to dispose off those assets
without involving huge losses.

10
 Need and Importance of Capital
Budgeting
4. Long-term effect: Capital budgeting not only
reduces the cost but also increases the
revenue in long-term and will bring significant
changes in the profit of the company by
avoiding over or more investment or under
investment. Over investments leads to be
unable to utilize assets or over utilization of
fixed assets. Therefore before making the
investment, it is required carefully planning
and analysis of the project thoroughly.
11
Importance of Capital Budgeting
• Large Amount
• Irreversibility
• Complexity
• Risk
• Long term implications
Benefits of Capital Budgeting Decision:

• Capital Budgeting decisions evaluate a proposed project to

forecast return from the project and determine whether return
from the Project is adequate.
• Capital Budgeting decisions evaluate expenditure decisions
which involve current outflow of funds but arc likely to produce
benefits over a period of time more than one year.
12
 Classification of Capital Budgeting
Decision
On the basis of firms existence
• Replacement Decision
• Modernization Decision
• Expansion Decision
• Diversification Decision
• Setup of new business

13
 Classification of Capital Budgeting
Decision
On the basis of decision situation
• Mutually Exclusive Decision
• Accept/Reject Decision
• Complimentary Decision

14
• Capital Budgeting is the planning process
used to determine a firm's long term
investments such as new machinery,
replacement machinery, new plants, new
products and research & development
projects.

15
CAPITAL BUDGETING PROCESS
• Capital budgeting is a difficult process to the investment of
available funds. The benefit will attained only in the near
future but, the future is uncertain. However, the following
steps followed for capital budgeting, then the process may
be easier are.
1. Identification of various investments proposals: The
capital budgeting may have various investment proposals.
The proposal for the investment opportunities may be
defined from the top management or may be even from the
lower rank. The heads of various department analyse the
various investment decisions, and will select proposals
submitted to the planning committee of competent authority.
2. Screening or matching the proposals: The planning
committee will analyse the various proposals and
screenings. The selected proposals are considered with the
available resources of the concern. Here resources referred
as the financial part of the proposal. This reduces the gap
between the resources and the investment cost
16
CAPITAL BUDGETING PROCESS
3. Evaluation: After screening, the proposals are evaluated
with the help of various methods, such as pay back period
proposal, net discovered present value method, accounting
rate of return and risk analysis. The proposals are evaluated
by.
(a) Independent proposals
(b) Contingent of dependent proposals
(c) Mutually exclusive proposals.
• Independent proposals are not compared with another
proposals and the same may be accepted or rejected.
• Whereas higher proposals acceptance depends upon the
other one or more proposals. For example, the expansion of
plant machinery leads to constructing of new building,
additional manpower etc.
• Mutually exclusive projects are those which competed with
other proposals and to implement the proposals after
considering the risk and return, market demand etc.
17
CAPITAL BUDGETING PROCESS
3. Evaluation: After screening, the proposals are evaluated
with the help of various methods, such as pay back period
proposal, net discovered present value method, accounting
rate of return and risk analysis. The proposals are evaluated
by.
(a) Independent proposals
(b) Contingent of dependent proposals
(c) Mutually exclusive proposals.
• Independent proposals are not compared with another
proposals and the same may be accepted or rejected.
• Whereas higher proposals acceptance depends upon the
other one or more proposals. For example, the expansion of
plant machinery leads to constructing of new building,
additional manpower etc.
• Mutually exclusive projects are those which competed with
other proposals and to implement the proposals after
considering the risk and return, market demand etc.
18
CAPITAL BUDGETING PROCESS
4. Fixing property: After the evolution, the planning committee
will predict which proposals will give more profit or economic
consideration. If the projects or proposals are not suitable for
the concern's financial condition, the projects are rejected
without considering other nature of the proposals.

5. Final approval: The planning committee approves the final

proposals, with the help of the following:
(a) Profitability
(b) Economic constituents
(c) Financial violability
(d) Market conditions.
• The planning committee prepares the cost estimation and
submits to the management.

19
 Investment Criterion Method of Capital
Budgeting:

The capital budgeting appraisal methods or techniques for

evaluation of investment proposal; will help the company to
decide the desirability of an investment proposal depending
upon their relative income generating capacity and rank them
in order of their desirability. These methods provide the
company a set of norms on the basis of which either it has to
accept or reject the investment proposal Therefore a sound
appraisal methods should enable the company to measure the
real worth of the nvestmen proposal. The appraisal methods
should posses several good characteristics which are
mentioned below.

20
CAPITAL BUDGETING PROCESS
4. Fixing property: After the evolution, the planning committee
will predict which proposals will give more profit or economic
consideration. If the projects or proposals are not suitable for
the concern's financial condition, the projects are rejected
without considering other nature of the proposals.

5. Final approval: The planning committee approves the final

proposals, with the help of the following:
(a) Profitability
(b) Economic constituents
(c) Financial violability
(d) Market conditions.
• The planning committee prepares the cost estimation and
submits to the management.

21