Sem III Midterm Points.xlsx
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Sr No Topic Keywords
1
Capital Expenditure Decision - Two Categories
1. Screening decision
2. Preference decision
2 Marginal revenue vs Marginal cost
3
Captal budgeting is an evaluation technique
having 3 steps
1. classification of investment proposals
2. measuring benefits.
3. ranking proposals
Known as profitability analysis
project evaluation
4
Classification of investment projects:
1. Mujtually exclusive
2. Independent
3. Contingent
4. Replacements
5
Evaluation of Investment oppurtunities (2
stages)
6
1. Formulation of capital expenditure proposal
in terms of cash flows. 1. out flow and inflow of cash
7 A. Estimating net investment outlay
Old machine, new machine
charges for freight in, installation,disposal of old machine(salvage),
8B. Estimating streams of net cash benefits after
taxes
Recurring cash inflows.
Benefits computed after tax,
tax liability is calculated after charging
depreciation
9
10 2. Evaluation of cash flows in their time value
11 A. Theory of interest Fn = P (1 + r) ^n . .. Pg 12
12 B. Computation of present value
P = Fn / {(1 + r)^n} Pg 13
Discounting
13 C. Present Value of a series of cash flows Series of cash flows is called annuity
14
15 Investment in working capitalCurrent assets Account receivable &
inventory.
Chapter 1 Capital Expenditure Deci
Chapter 2 Investment decision Met
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1 Average rate of return method
ARR = (Average after tax annual net profit)
/ (Original Investment)
ARR = Avg annual net profit / (Original
investment/2)
2 Accept reject rule cut off rate
3 Evaluation4 Drawbacks of ARR
5
6 Pay back methodSimplest method employed by industrial
practioners
7 PBP
PBP = CO / CF
CO = Cash outflow of project
CF = Cash inflow
8 Accept reject rule Standard
9 Evaluation useful to company with shortage of cash
10 Drawbacks of PBP
continues to be most frequently used
method for making investment decisions
particularly in US industries
Machinery & allied products survey: two
thirds of american companies employ PBP
11
12 Discounted Pay Back Methoddeveloped to overcome time value
drawback of PBP13
14 Internal Rate of Return Method
AKA Time adjusted return,
discounted rate of return,
& yield rate
15 Internal Rate of Return for uneven cash flows
16 Process of interpolation process of finding odd rates of return
17 Accept reject value
18 Evaluation
19 Drawbacks of IRR
20
21 Present Value Method NPU Formula
22 Accept reject rule Present value of cash earnings
23 Evaluation Simplicity
24 drawbacks of PVM
magnitude of investment outlay is not
taken into consideration together with net
cash benefits
25
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26 Profitability index method to get over drawback of PVM
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28 Replacement decision
29
30Comparison between present value approach &
Internal rate of return approach
basic diff is the assuption regarding
interest rate and treatment of
depreciation31 Terminal value investment criterion
32 Annual benefit cost ratio
33 Net cost approach
34
35 Capital Rationing
36
37 Cases
38 Durpan rubber company
39 Indian commercial bank40 Lake side oil company
41
1 Overview
2 Concept of certainty, risk and uncertainty
Project variability
Uncertainty is a subjective phenomenon
risk & uncertainty are used interchangably
3 Business risk & financial risk
4 Sources of risk
1. Size of investment
2. Reinvestment of cash flows
3. Variability of cash flows
4. Life of the project
5
6 Measurement of risk
7 1. Probability Distribution
8 2. Standard deviation as a measure of risk
higher the probability distribution of
expected future return, smaller is the risk
of project and vice versa
Most widely used statistical technique of
standard deviation is employed
93. Coefficient of variation as a relative measure
of risk
larger the coefficient of variation, greater
the risk
10
Chapter 3 Risk in investment deci
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11Utility Theory and risk analysis in investment
decisions
Decision is based finally on management's
subjective evaluation of risk.
Utility theory developed by Milton
Friedman and L. J Savage
1213 Risk analysis approaches Two types
14 1. Simulation approach
1. Market related factors
2. Investment related factors
3. Cost related factors
15 -----> Practical test
David B. Hertz proposed the use of
simulation approach to secure expected
return and dispersion about this expected
return for an investment proposal
16 2. Sensitivity analysis used to locate and assess potential impactof risk on a project's profitability
17
18 Methods of adjusting risk two types
19 1. Informal method common method of adjusting risk
20 2. Formal Methods Two types
21 a. Risk adjusted discount rate
22 b. certainty equivalent approachtwo steps taken:
23
24 Cases25 British bakeries
26 Arvind toy manufacturing ltd
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Section Page No.
Middle 4
Bottom (Capital Budgeting technique) 5
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