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Understanding Capital Budgeting Decisions

CASE SLIDE, FINANCIAL MANAGEMENT
Institute of Management Technology, Nagpur, 11 Slides
AUTHOR(S) : Prof. Anil Kshatriya, Institute of Management Technology Nagpur

Teaching Note Preview

Understanding Capital Budgeting Decisions

 

Synopsis

Business organizations have to allocate funds judiciously towards long-term capital investments, to ensure good returns and shareholder value maximization. Small businesses and newly established ventures (startups) have very limited funds in the initial phase where the focus is on creating and nurturing customer base and brand identity. The financial priority of such entities is to rationalize the capital spending in order to earn positive return on investment.

A good understanding of how to measure and manage investment in long-term assets can enable entrepreneurs to keep control on funding estimates in successive phases of maturity and growth. This case slide is designed aims to explain fundamental concept of Payback Period and Net Present Value (NPV) to the students undergoing a Corporate Finance or Financial Management course.

Expected Learning Outcomes

  • • Understand what are Capital Budgeting decisions of business organizations
  • • Learn two important evaluation methods for accepting or rejecting a capital expenditure (long-term investment) proposal namely Payback Period and NPV
  • • Learn about factors affecting the choice of evaluation technique for capital budgeting decisions

 

Case Positioning and Setting

The case slide can be used for an introductory course in Financial Management or Corporate Finance at Undergraduate level – To explain fundamental concept of Payback Period and Net Present Value (NPV)............

Assignment Questions

I. What is a payback period?
II. What is Present Value of Money?
III..........

Case Slide Discussion

Financial Management has two sides namely Financing and Investing. Financing side looks at where to raise the funds from. Investing side looks at where to invest the funds raised for the business. The main objective of the business is to ensure that investments made in promising future opportunities earn a return, which is not only greater than the cost of capital but is also able to generate a surplus for promoters and shareholders. Investments can be both short term and long term in nature. In this session we are essentially going to talk about Long Term Capital Investments decisions. Obviously, business entities need detailed investment planning before they decide to take a call on huge amount of financial commitment..................

Payback Period – Concept and Example

I. What is a payback period?

The answer to this very crucial question depends on two factors –

a. What is your annual net cash flow i.e., Cash Inflow minus Cash Outflow
b. Size of Initial Capital Investment

• The number of years required to recover a startup’s cost, or “How long does it take to get our money back?”
• Calculated by adding business cash inflows to its initial cost until the cumulative cash flow for the project turns positive.

Example of Payback Period

..........................

Exhibits

Exhibit (TN)-I: Capital Budget for Baker’s Bay’s First 4 years of Operations (in INR)

$5.48
Rs 0
Product code: FIN-6-0029, FIN-6-0029A

Abstract

This case slide will enable the instructor to discuss the basics of capital budgeting decisions. Business organizations have to allocate funds judiciously towards long-term capital investments, to ensure good returns and shareholder value maximization. Small businesses and newly established ventures (startups) have very limited funds in the initial phase where the focus is on creating and nurturing customer base and brand identity. The financial priority of such entities is to rationalize the capital spending in order to earn positive return on investment.

A good understanding of how to measure and manage investment in long-term assets can enable entrepreneurs to keep control on funding estimates in successive phases of maturity and growth. The investment decisions have to take into account factors like cost of capital and net cash flows from the project. Unless the project yields positive return, it does not make financial sense to divert funds into such an investment. The case slide provides a summarized explanation for the same using a small example of capital investment decision dilemma.



Pedagogical Objectives

  • To understand what are Capital Budgeting decisions of business organizations
  • To learn two important evaluation methods for accepting or rejecting a capital expenditure (long-term investment) proposal namely Payback Period and NPV
  • To learn about factors affecting the choice of evaluation technique for capital budgeting decisions

Case Positioning and Setting

The case slide can be used for an introductory course in Financial Management or Corporate Finance at Undergraduate level – To explain fundamental concept of Payback Period and Net Present Value (NPV)



This Case Pack Includes:
- Abstract
- Case Slide
- Teaching Note (**ONLY for Academicians)
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