NATURE AND TECHNIQUES OF CAPITAL BUDGETING PART 2 WITH MCQ

• NATURE AND TECHNIQUES OF CAPITAL BUDGETING FOR NET COMMERCE/MANAGEMENT PART 2
  WWW.GARGSHASHI.COM
  FINANCIAL MANAGEMENT
• IMPROVEMENT IN TRADITIONAL APPROACH TO PAY BACK PERIOD
• PAY BACK RECIPROCAL : ANNUAL CASH FLOW M/INITIAL INVESTMENT
• THIS METHOD CAN BE USED WHEN TWO CONDITIONS ARE SATISFIED:

1. EQUAL CASH INFLOWS ARE GENERATED EVERY YEAR
2. PROJECT HAS LONG PERIOD WHICH MUST BE AT LEAST TWICE THE PAYBACK PERIOD

• USEFUL TECHNIQUE TO ESTIMATE THE TRUE RETURN BUT MAJOR LIMITATION IS  DOES NOT SATISFY THE CONDITION.
• SOMETIMES IT IS EMPLOYED TO ESTIMATE THE INTERNAL RATE OF RETURN

• POST PAY BACK PERIOD METHOD
• ONE OF THE LIMITATION OF THE PAY BACK PERIOD METHOD IS THAT IT IGNORES THE LIFE OF THE PROJECT BEYOND THE PAY BACK PERIOD
• POST PAY BACK PERIOD METHOD IS TAKES INTO ACCOUNT THE PERIOD BEYOND PAY BACK PERIOD.
• ALSO KNOWN AS SURPLUS LIFE OVER PAY BACK METHOD
• THE PROJECT WHICH GIVES THE GREATEST POST PAY BACK PERIOD MAY BE ACCEPTED
• METHOD IS SUITABLE :

1. WHERE THE VARIOUS PROJECTS UNDER CONSIDERATIONS DO NOT DIFFER SIGNIFICANTLY AS TO THEIR SIZE
2. EXPECTED CASH INFLOWS ARE EVEN THROUGHOUT THE LIFE OF THE PROJECT

• PROBLEM

1. INITIAL OUTLAY=1,00,000
2. ANNUAL CASH INFLOW AFTER TAX BUT BEFORE DEPRECIATION=20,000
3. ESTIMATED LIFE=8
4. PAY BACK PERIOD=INVESTMENT/ANNUAL CASH INFLOW
5. 1,00000/20,000=5 YEARS
6. POST PAY BACK PROFITABILITY=3 X  20,OOO=60,000
7. POST PAY BACK PROFITABILITY INDEX= (60,000/1,00,000)X 100=60%

• DISCOUNTED PAY BACK PERIOD

1. LIMITATION OF  THE PAY BACK METHOD IS THAT IT IGNORES THE TIME VALUE OF THE MONEY.
2. IMPROVEMENT OVER THIS METHOD CAN BE MADE BY EMPLOYING THE DISCOUNTED PAY BACK PERIOD
3. PRESENT VALUES OF ALL CASH INFLOWS AND OUTFLOWS ARE COMPUTED AT APPROPRIATE DISCOUNT RATE
4. THE PRESENT VALUES OF ALL INFLOWS ARE CUMULATED IN ORDER TIME
5. THE TIME PERIOD AT WHICH THE CUMULATED PRESENT VALUE OF CASH INFLOWS EQUALS THE PRESENT VALUES OF CASH OUTFLOW IS KNOWN AS DISCOUNTED PAY BACK PERIOD.
6. THE PERIOD WHICH GIVES A SHORTER DISCOUNTED PAYBACK PERIOD IS ACCEPTED
7. THE MAIN LIMITATION IT DOES NOT TAKE INTO CONSIDERATION THE ENTIRE SERIES OF CASH FLOWS

• PROBLEM
• SOLUTION
• SOLUTION
• CUMULATIVE PRESENT VALUE OF CASH INFLOWS AT THE END OF THIRD YEAR IS
• 4,97,200
• AT FOURTH YEAR IT IS 6,33,800
• DISCOUNTED PAYBACK PERIOD FALLS IN BETWEEN 3 AND 4 YEARS
• OUTFLOW=6,00,000
• THIRD YEAR=4,97,200
• REMAINING=1.02,800
• DISCOUNTED PAY BACK PERIOD= 3 YEARS + 1,02,800/1,36,600
• = 3  YEARS NINE MONTHS

• MCQ
• WHICH OF THE FOLLOWING STATEMENT IS FALSE?

1. THE OPPORTUNITY COST OF AN INPUT IS CONSIDERED IN CAPITAL BUDGETING
2. CAPITAL BUDGETING DECISIONS ARE REVERSIBLE IN NATURE
3. CASH FLOW AND ACCOUNTING PROFITS ARE DIFFERENT
4. AN EXPANSION DECISION IS CAPITAL BUDGETING DECISIONS

• WHICH OF THE FOLLOWING STATEMENT IS NOT CORRECT?

1. THE COST OF CAPITAL IS REQUIRED RATE OF RETURN TO ASCERTAIN THE VALUE OF THE FIRM
2. DIFFERENT SOURCES OF FUNDS HAVE A SPECIFIC COST OF CAPITAL RELATED TO THAT SOURCE ONLY
3. COST OF CAPITAL DOES NOT COMPRISE ANY RISK PREMIUM
4. COST OF CAPITAL IS BASIC DATA FOR NPV TECHNIQUE

• WHICH OF THE FOLLOWING IS NOT TRUE WITH REFERENCE TO CAPITAL BUDGETING

1. CAPITAL BUDGETING IS RELATED TO ASSET REPLACEMENT DECISIONS
2. COST OF CAPITAL IS EQUAL TO MINIMUM REQUIRED RATE OF RETURN
3. TIMING OF CASH FLOW IS RELEVANT
4. EXISTING INVESTMENT IN A PROJECT IS NOT TREATED AS SUNK COST

• WHICH OF THE FOLLOWING IS NOT TRUE WITH REFERENCE TO CAPITAL BUDGETING

1. CAPITAL BUDGETING IS RELATED TO ASSET REPLACEMENT DECISIONS
2. COST OF CAPITAL IS EQUAL TO MINIMUM REQUIRED RATE OF RETURN
3. TIMING OF CASH FLOW IS RELEVANT
4. EXISTING INVESTMENT IN A PROJECT IS NOT TREATED AS SUNK COST

• WHICH OF THE FOLLOWING IS NOT FEATURE OF THE PAYBACK PERIOD

1. IT IS SIMPLY A METHOD OF COST RECOVERY AND NOT PROFITABILITY
2. IT DOES NOT CONSIDER THE TIME VALUE OF  MONEY
3. IT DOES NOT CONSIDER THE RISK ASSOCIATED WITH PROJECTS
4. IT IS VERY DIFFICULT TO CALCULATE

·         IN CAPITAL BUDGETING,THE TERM CAPITAL RATIONING IMPLIES

1. THAT NO RETAINED EARNING ARE AVAILABLE
2. THAT LIMITED FUNDS ARE AVAILABLE FOR INVESTMENT
3. THAT NO EXTERNAL FUNDS ARE RAISED
4. THAT NO FRESH INVESTMENT IS REQUIRED IN CURRENT YEAR

• CAPITAL BUDGETING IS ALSO KNOWN AS

1.     CAPITAL EXPENDITURE DECISIONS

2.     PLANNING CAPITAL EXPENDITURE

3.     INVESTMENT DECISION MAKING

4.     ALL OF THE ABOVE

• CAPITAL EXPENDITURE IS ONE WHICH IN INTENDED TO BENEFIT

1. CURRENT
2. PAST
3. FUTURE
4. NONE OF THESE

• CAPITAL BUDGETING IS LONG TERM PLANNING FOR MAKING AND FINANCING PROPOSED CAPITAL OUTLAY. DEFINITION IS GIVEN BY

1. MILTON H SPENCER
2. CHARLES T HORNGREEN
3. RM LYNCH
4. JOEL DEAN

• CAPITAL BUDGETING GENERALLY REFERS TO ACQUIRING INPUTS WITH LONGER RUN RETURNS. THIS DEFINITION IS GIVEN BY

1. CHARLES T HORNGREEN
2. RM LYNCH
3. MAX D RICHARD AND PAUL S GREEN LAW

• THE PROCESS OF ALLOCATION OR DISTRIBUTION OF AVAILABLE CAPITAL FUNDS OVER VARIOUS CAPITAL PROJECTS ACCORDING TO THEIR RANK AND PROFITABILITY IS CALLED:

1. CAPITAL RATIONING
2. CAPITAL PLANNING
3. CAPITAL BUDGETING
4. NONE OF THESE

·         WHICH OF THE FOLLOWING METHOD DOES NOT CONSIDER THE PROFITABILITY OF THE WHOLE LIFE OF THE PROJECT

1. INTERNAL RATE OF RETURN
2. PAYBACK METHOD
3. PRESENT VALUE INDEX
4. NET PRESENT VALUE METHOD

• IMPORTANT DEFINITION
• CAPITAL BUDGETING IS  CONCERNED WITH DESIGNING AND CARRYING THROUGH A SYSTEMATIC INVESTMENT PROGRAMME
• CHARLES T H HORNGREEN
• WHICH OF THE FOLLOWING METHOD DOES NOT CONSIDER  THE  PROFITABILITY OF THE WHOLE LIFE OF THE PROJECT?

1. PAYBACK PERIOD
2. INTERNAL RATE OF RETURN
3. PRESENT VALUE OF INDEX METHOD
4. NET PRESENT VALUE METHOD

• WHICH OF THE FOLLOWING VARIABLE IS NOT KNOWN IN INTERNAL RATE OF RETURN METHOD OF CAPITAL BUDGETING?

1. AMOUNT OF CASH INFLOWS
2. LIFE OF THE PROJECT
3. AMOUNT OF CASH FLOWS
4. DISCOUNT RATE

•