Capital Budgeting Capital Budgeting is done because companies need to make Acceptance/rejection decisions for buying fixed assets etc. Features of fixed assets : Investments upfront and returns take a long time. Risk is long term Expenses are indivisible and lumpy Ex. If HUL wants to put up a synthetic detergent plant of 50 cr. Rs. -> by spending 25 Cr. Rs. , the plant wont be operational at half the capacityS The Capex decisions are irreversible Projected P&L : Less Sales Raw Materials Utilities Employee Cost Depreciation Sales and Distn.
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Repair and maintenance + Administrative Exp. Int. on Working capital Total Cost PBT Tax PAT PAT + Depreciation Non manufacturing Expenses x Cash outflow, Inflow: Cash outflow – Investment, Incremental working capital (as all the capacity won’t be utilised in some cases) Cash Inflow – Operating cash flow, Terminal cash inflow = Salvage value of fixed asset, recovery of Net working capital Numerical Prakash Steel – Refer to Excel Finished Goods costing – 1. Absorption costing 2. Marginal costing Most companies use absorption costing and tax norms also say so.
In DCF, marginal costing should be used. Employee cost is a fixed cost. Receivables on sales not COGS. If excise duty -> sales(1-e) = Net Sales. But in Working capital calculation, excise should be considered, since the excise will be loaded on the receivables. Calculate using both the methods and see Q. To Whom does the NPV belong to? – to shareholders and the Market capitalisation of the company goes up by NPV Concepts : Why ignore interest rates ? “Principle of separation between financing and investment decision.
” Please remember that we are making an investment decision, thus, leave the financing part alone. NEVER mix them. Cash Inflow, Cash Outflow, NCF – Investment decisions WACC – Financing decision Allocated Rent Cash flows marginal to the decision should be considered. But in case of alternative use of an asset, the benefit foregone should be considered. When we make the decision, no incremental rent arised. And this is “Allocated” rent. Period. Incremental Principle All cash flows should be incremental. Hence, marginal costing should be used while valuing finished goods.