Capital budgeting is the evaluation of long-term investment projects (machines, new product lines, expansion) that involve large cash flows over many years. Because these decisions are hard to reverse and affect the firm’s value, methods like NPV and IRR are widely used.
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Capital budgeting is the process of evaluating and selecting long-term investment proposals whose benefits are expected to extend beyond one year.
Typical steps (write as a flow for 5-mark theory):
Identify projects → Estimate cash flows → Assess risk → Choose discount rate → Apply technique (NPV/IRR/PI/PB) → Select/Rank → Implement → Review (post-audit)
Payback period is the time required to recover the initial investment from cash inflows.
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Decision rules:
These rules indicate whether the project adds value.
Payback (equal inflows) = Initial outlay / Annual inflow
= 1,00,000 / 25,000 = 4 years.
Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.
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Capital budgeting is the evaluation of long-term investment projects (machines, new product lines, expansion) that involve large cash flows over many years. Because these decisions are hard to reverse and affect the firm’s value, methods like NPV and IRR are widely used.
Exam scoring comes from:
You should be able to:
Capital budgeting is the process of evaluating and selecting long-term investment proposals whose benefits are expected to extend beyond one year.
Typical steps (write as a flow for 5-mark theory):
Identify projects → Estimate cash flows → Assess risk → Choose discount rate → Apply technique (NPV/IRR/PI/PB) → Select/Rank → Implement → Review (post-audit)
Payback period is the time required to recover the initial investment from cash inflows.
If equal inflows: If unequal inflows: cumulatively add inflows until initial outlay is recovered.
Limitation: ignores time value and cash flows after payback.
DPB is similar to payback but uses discounted cash inflows (PV of inflows). It considers time value but still ignores cash flows after payback.
NPV is the difference between PV of cash inflows and PV of cash outflows:
NPV is consistent with wealth maximisation.
IRR is the discount rate that makes NPV = 0.
IRR is often found by trial-and-error / interpolation in basic problems.
PI is useful under capital rationing (limited funds) for ranking.
Exam line: “When NPV and IRR conflict for mutually exclusive projects, NPV is preferred for wealth maximisation.”
Initial outlay = ₹1,00,000. Cash inflows = ₹40,000 each year for 3 years. Discount rate = 10%.
Working table:
NPV = 99,440 − 1,00,000 = −560 (approx.) → Reject (slightly negative).
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Capital budgeting is a structured process to select long-term projects that maximise firm value.
Identify projects → Estimate cash flows → Assess risk → Choose discount rate (cost of capital) → Apply technique (NPV/IRR/PI/PB) → Select/Rank → Implement → Post-audit
A systematic process reduces decision errors and supports wealth maximisation.