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Capital budgeting...!!

Nihar (IPCC) (566 Points)

26 April 2011

everybody

i am having doubt which technique..to use...n when...in which situation...????

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9 Replies

(Guest)

i didnt get your question.. cant u explain briefly

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Nihar (IPCC) (566 Points)
Replied 26 April 2011

which techniqur to be given preference in capital bugeting....????i.e.

i mean to say when to use NPV or IRR or Pay back or disc. Pay back...or any other...??

n answer to be more reliable...??

vinay sharma (CA final (Article)) (327 Points)
Replied 26 April 2011

if u understant or read the question carefully u may understand it is given in the question....if nothing mention then use NPV technique for better result..................(rply is according to my knowledge).

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Rechtsan ({ffft) (383 Points)
Replied 26 April 2011

NPV is easy

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Prashanth (Chartered Accountant) (2322 Points)
Replied 27 April 2011

Always any decision in respect of capital budeting should be analysed with the help NPV,because as it shows wealth of the share hoders in aboslute figures,whereas IRR or other method does not do that.

So accordingly NPV has taken as base in evaluating the project.

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CA.Naveen Kailkhuri (CA) (38 Points)
Replied 27 April 2011

NPV and IRR, Both are primarily used in capital budgeting. But both of them have different significance. This basically depends upon the question you are attempting. Both NPV and IRR may be used simultaneously in evaluating an Investment Proposal.

To do this, the firm estimates the future cash flows of the project and discounts them into present value amounts using a discount rate that represents the project's cost of capital and its risk. Next, all of the investment's future positive cash flows are reduced into one present value number. Subtracting this number from the initial cash outlay required for the investment provides the net present value (NPV) of the investment.

i.e, NPV = PV of Inflow – PV of Outflow

Let's illustrate with an example: suppose ABC Ltd. wants to buy a small publishing company. ABC determines that the future cash inflows generated by the publisher, when discounted at a 12% annual rate, yields a present value of Rs.23.5 million. If the publishing company's owner is willing to sell for Rs.20 million, then the NPV of the project would be Rs.3.5 million (Rs.23.5 - Rs.20 = Rs.3.5). The Rs.3.5 million dollar NPV represents the intrinsic value that will be added to ABC Media if it undertakes this acquisition.

So, ABC's project has a positive NPV, but from a business perspective, the firm should also know what rate of return will be generated by this investment. To do this, the firm would simply recalculate the NPV equation, this time setting the NPV factor to zero, and solve for the now unknown discount rate. The rate that is produced by the solution is the project's internal rate of return (IRR).

Suppose, in the given example the IRR comes to 17.15% then we will say that ABC Ltd. has a project with a 17.15% return. If there were a project that ABC could undertake with a higher IRR, it would probably pursue the higher-yielding project instead.

Thus, you can see that the usefulness of the IRR measurement lies in its ability to represent any investment opportunity's return and to compare it with other possible investments.

From the above you may find the basic difference in NPV and IRR is that NPV is an evaluation in absolute MONETARY terms while IRR is determined as a RATE (%).

Ultimately, you will have to check the question and decide the way of action so that you don’t waste your time in calculating, what is not asked to you.

In my personal opinion, the examiner will give you marks in both the situations, whether you have decided the feasibility of the Project either by NPV or IRR.

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