Capital Budgeting
Capital Budgeting is a vital process used by companies and banks to make long-term investment decisions. These decisions involve spending a large amount of money today to earn profits over many future years. For example, when a bank decides to buy a new software system or open fifty new branches, it is a capital budgeting decision. These choices are very important because they affect the success of the business for a long time.
Concepts (3)
IRR is the expected percentage return that a project will generate. It is the specific interest rate at which the NPV becomes exactly zero. If the IRR is higher than the cost of borrowing money, the project is considered good.
IRR is the expected percentage return that a project will generate. It is the specific interest rate at which the NPV becomes exactly zero. If the IRR is higher than the cost of borrowing money, the project is considered good. Example: If a project has an IRR of 15% and the bank loan interest is 10%, the project is profitable.
This is the simplest method of capital budgeting. It calculates how many years it takes for a project to pay back the original cost. It does not look at profits made after the payback date.
This is the simplest method of capital budgeting. It calculates how many years it takes for a project to pay back the original cost. It does not look at profits made after the payback date. Example: If a machine costs ₹50,000 and earns ₹10,000 every year, the payback period is 5 years. Companies usually prefer projects with a shorter payback period.
NPV is the difference between the present value of cash coming in and the cash going out. It uses a discount rate to bring all future money to today's value. If the result is positive, the project adds value to the company.
NPV is the difference between the present value of cash coming in and the cash going out. It uses a discount rate to bring all future money to today's value. If the result is positive, the project adds value to the company. Example: If you spend ₹100 today and the present value of future earnings is ₹120, the NPV is ₹20. Since it is positive, you should accept the project.
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Start Lesson: Internal Rate of Return (IRR)