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Payback period allude to the amount of time it takes to reach the cost of an investment. In simple terms, it is time taken for a firm to reach breakeven point.AdvantagesA short payback period can improve the liquidity of the business quickly.Shorter paybacks mean more attractive investments.Payback is easy to compute.DisadvantageIt does consider time value of money.FormulaPay back (even cash flows) =$\frac{investment\:required}{Net\:(annual\:cash\:inflows}$Pay back (uneven cash flows) =$cummulative\:cash\:flow(near\:to\:investment)\:+\:\frac{remaining\:amount\:at\:the\:start\:of\:year}{cash \:flow\:during\:the\:year}$ExamplesCompany A is considering to purchase a new equipment to increase its production and revenue. Useful life of the equipment is 10 years and the company’s maximum desired payback is 4 years.Initial cost ... Read More
Profitability index (PI) measures the ratio between the present value of future cash flow and the initial investment. This is used for ranking investment projects and value created per unit of investment. PI is also known as profit investment ratio (PIR) or the value investment ratio (VIR).PI >1 (project generates value and the company may go with the project).PI=1 (project breaks even and the company is indifferent between proceeding or not proceeding with the project).PI1)Therefore, project generates value and the company may go with the project.
ARR stands for Accounting Rate of Return. It is one of the Non- Discounted cash flow techniques used for calculating capital budgeting.ARR is the average net income of an asset (anticipated) divided by its average capital cost. It is generally expressed as an annual percentage. ARR does not take in account the time value of money or cash flows, which are integral part of maintaining a business.ARR is useful for a quick calculation of an investments probability.ARR is mainly used for comparison between multiple projects to determine the ARR for each.ARR is mainly used for comparison between multiple projects to ... Read More
Net present value (NPV) is the value of all future cash flows over the entire life of an investment discounted to the present. It is one of the most reliable techniques used in capital budgeting, because it is based on discounted cash flow approach. It may be positive, zero or negative.Present value of cash inflow > present value of cash outflow (NPV is positive and project is acceptable).Present value of cash inflow = present value of cash outflow (NPV is zero and project is acceptable).Present value of cash inflow < present value of cash outflow (NPV is negative and project ... Read More
Capital budgeting is a process a business undertakes to evaluate potential major projects or investments. It is a planning process used to decide the company’s long term investments like new machinery, new plants, new products, research development projects etc. are worth the funding through firm capitalisation. Primary objective of investments is to increase the value of the firm to the shareholders.Capital budgeting usually involves the following −Computation of each projects future accounting profit by period.The cash flow by period.The present value of cash flow after considering time value of money.The number of years it takes for a project cash flow ... Read More
LiabilitiesRs.AssetsRs.Equity share capital15000Fixed assets (less depreciation Rs.12000)360007% preference share capital3500Reserves and surplus110006% mortgage debentures16500Current liabilitiesCurrent assetsCreditors1300Cash1790Bills payable2200Investments (12%)4055Outstanding expenses500Sundry debtors4740Stock6415Tax provision30005300053000Additional information − Net sales: Rs.55000, Cost of goods sold: Rs. 48600, Net income before Tax: Rs. 3500, Net income after Tax: Rs. 1400SOLUTIONThe solution is as follows −Short term solvency ratioscurrent ratio = current assets/current liability = 17000/7000 => 2.43:1liquid ratio = liquid ratio/ current liability = (1790+4055)/7000 => 5845/7000=> 0.84:1Long term solvency ratiosproprietary ratio = proprietors fund/total assets = (1500+3500+11000)/53000=> 16000/53000 => 0.32:1(Proprietors fund or shareholders fund = equity share capital + preference share + capital + Reserve ... Read More
Liabilities20042005Assets20042005Share capital100000110000Land and building6000060000Profit and loss a/c Loans2000023000Plant and machinery3500045000Loans-1000stock2000025000Creditors1500018000Debtors1800028000Bills payable50004000Bills receivable20001000Cash500060001400001650005000165000SOLUTIONThe solution is as follows −InflowRs.OutflowRs.Balance b/d5000Purchase of plant10000Issued share capital10000Increase current AssetsLoan10000StockCash opening profit3000Decrease in bills payable5000Decrease in bills1000Balance c/d10000Receivable30001000Increase in creditors60003200032000
Liabilities2003 (Rs)2004 (Rs.)Assets2003 (Rs.)2004 (Rs.)Capital54825482Cash and balance with RBI67058025543697Reserve and surplus69963008406754Balance with banks and money at call short notice37816115349090Deposits7354078879299033Investments4226011046435410Borrowings672177262960Advances5794769962502390other liabilities and provisions15147661632769Fixed assets369499401240Other assets408108640325228272951389606998115145807124264349solutionThe solution is as follows−PARTICULARS2003 (Rs.)Percentage2004 (Rs.)PercentageAssetsTotal current assetsCash and balance with RBI67058025.8255436974.46Balance with banks and money at call and short notice37816113.2853490904.30Total current assets104874139.10108927878.86Fixed assetsInvestments4226011036.704643541037.37Advances5794769950.336250239050.29Fixed Assets36949900.324012400.32Other Assets408108603.5540325223.25Total Fixed Assets10465839490.9011337156291.23Total Assets (TA)115145807100.00124264349100.0Current liabilitiesBorrowings6721770.812629600.29Other liabilities and provisions15147661.8316327691.82Total Current Liabilities21869432.6418957292.11Fixed liability capital54820.00754820.006Reserves surplus69963008.4684067549.38Deposits7354078888.897929903388.50Total Fixed Liabilities8054257097.368771126997.89Total liability82729513100.0089606998100.00
Liabilities20042005Assets20042005Share capital150000180000Land and building8500085000Profit and loss a/c Loans3500042000Plant and machinery5400070000Loans200015000stock3050050000Creditors1700023000Debtors2550045000Bills payable30001000Bills receivable50002000Cash70009000207000261000207000261000SOLUTIONThe solution is as follows − Working capital= current assets – current liabilitiesChanges in working capitalParticulars2004 (Rs.)2005 (Rs.)Incharge (Rs.)Decharge (Rs.)Current AssetsStock305005000019500Debtors255004500019500Bills Receivable500010002000Cash700090002000Total (X)68000106000Current liabilitiesCreditors17000230006000Bills payable300010002000Total (Y)2000024000430008000X-Y480008200035000Increase in W.C.34000340004300043000FUNDS FLOW STATEMENTSourceRs.ApplicationRs.Issued share capital30000Purchase of plant and machinery16000Loan13000Increase in working capital34000Funds from operations70005000050000Funds from operations = 42000-35000 = 7000 (profit and loss a/c)Increase in working capital = 82000-48000 = 34000
YearDepositsAdvancesProfit199929585549782917751301120003834587510115298594580200146005530128007097382252002536681881428825076951620035878649015799280933680200463372248170362901181468SOLUTIONThe solution is as follows −For DepositsMake Base year as 1990 => 29585549 (100%)YearDepositsCTrend percentage (C*100)199929585549(D1)(D1/D1) = 1100200038345875(D2)(D2/D1) = 1.296129.6200146005530(D3)(D3/D1) = 1.555155.5200253668188(D4)(D4/D1) = 1.814181.4200358786490(D5)(D5/D1) = 1.987198.7200463372248(D6)(D6/D1) = 2.142214.2For Advances − Make Base year as 1990 => 7829177 (100%)YearAdvancesCTrend percentage (C*100)19997829177 (A1)(A1/A1)=1100200010115298 (A2)(A2/A1)= 1.292129.2200112800709 (A3)(A3/A1)= 1.635163.5200214288250 (A4)(A4/A1)= 1.825182.5200315799280 (A5)(A5/A1)= 2.018201.8200417036290 (A6)(A6/A1)= 2.176217.6For profits − Make base year as 1990 => 513011 (100%)YearProfitsCTrend percentage (C*100)1999513011 (P1)(P1/P1)= 11002000594580 (P2)(P2/P1)= 1.159115.92001738225 (P3)(P3/P1)= 1.439143.92002769516 (P4)(P4/P1)= 1.500150.02003933680 (P5)(P5/P1)= 1.820182.020041181468 (P6)(P6/P1)= 2.303230.3