#1 Capital Budgeting | SYBCOM | TYBAF | SEM 3 | SEM 5 | F M | Siraj Shaikh | B.Com/M.Com/CA/CS/CWA

Summary

The video discusses investment strategies with a focus on capital budgeting. The speaker explains how to maximize returns on investments using modern and traditional methods, such as payback periods, accounting rate of return (ARR), and internal rate of return (IRR). The video emphasizes understanding the basics before delving into advanced concepts and demonstrates calculations through practical examples, such as recovering investments in assets like computers and machinery. The approach is simplified for easy understanding, making it accessible for viewers looking to grasp key investment concepts and evaluate investment projects effectively.

Takeaways

• 💼 Capital budgeting helps in making investment decisions to maximize returns.
• 📊 Traditional methods like Payback Period and ARR (Accounting Rate of Return) were used in earlier times, but now modern methods like Discounted Cash Flow, Internal Rate of Return, and Modified IRR are applied.
• ⏳ Payback Period calculates how long it will take to recover the initial investment.
• 📈 Two types of cash flows exist: constant and fluctuating, requiring different approaches to calculate payback period.
• 🖥️ Example given: A computer purchased for ₹50,000 and income earned from it helps calculate how many years it takes to recover the investment.
• 🔄 Discounted Payback Period is the advanced version of the Payback Period, using discounting factors for a more accurate calculation.
• 📉 The formula for Payback Period is explained with real-life examples and case studies, including projects involving machine purchases.
• 🧮 Calculations involve dividing cash inflows and understanding how long it will take to cover initial outflows.
• 📅 Concepts of year fractions and months are introduced to refine the Payback Period further.
• 🔢 Depreciation and tax calculations are crucial for understanding the overall profit and cash flow in projects.

Q & A

What is capital budgeting in simple terms?

Capital budgeting is the process of deciding where to invest your money in order to earn the highest return. It involves making decisions on projects that will generate returns over time and choosing how to allocate financial resources.

What are the two traditional methods used in capital budgeting?

The two traditional methods used in capital budgeting are the Payback Period and Accounting Rate of Return (ARR). These methods were widely used before modern techniques were developed.

How is the Payback Period method defined?

The Payback Period method calculates how long it will take to recover the initial investment in a project. It looks at the number of years required for the cash inflows from the investment to equal the initial cash outflow.

What is the difference between Payback Period and Discounted Payback Period?

The Payback Period does not account for the time value of money, while the Discounted Payback Period considers the time value of money by discounting future cash flows to the present value before calculating the payback period.

What is the Internal Rate of Return (IRR)?

The Internal Rate of Return (IRR) is a modern capital budgeting method that calculates the discount rate at which the net present value (NPV) of a project is zero. It shows the project's potential return percentage.

How does the Modified Internal Rate of Return (MIRR) differ from IRR?

The Modified Internal Rate of Return (MIRR) considers both the cost of capital and the reinvestment rate of cash flows. Unlike IRR, MIRR provides a more accurate reflection of a project's profitability.

What is meant by constant cash inflow and fluctuating cash inflow?

Constant cash inflow refers to a situation where the returns or profits from an investment remain the same over time. Fluctuating cash inflow refers to variable returns where the amount changes each year.

How can fluctuating cash inflows affect the calculation of the Payback Period?

When cash inflows fluctuate, calculating the Payback Period requires applying a formula to account for the varying amounts each year, rather than simply dividing the initial investment by constant cash inflows.

Why do we add back depreciation when calculating cash inflow for a project?

Depreciation is a non-cash expense, so it is subtracted when calculating taxable income. However, when calculating actual cash inflow, it is added back because it does not represent an actual cash outflow.

What is the formula to calculate Payback Period when cash flows are constant?

When cash flows are constant, the Payback Period is calculated by dividing the initial investment by the annual cash inflow. For example, if you invest ₹1 lakh and receive ₹20,000 per year, the Payback Period would be 5 years.