Capital Budgeting

BIT International College[pic 1]

City of Tagbilaran

Graduate School

Name:                Roselle Mhae Itong

Subject:        Financial Management

Topic:                Fundamentals of Capital Budgeting

Professor:        Dr. Vanessa C. Macarayan, RCB, DPA

Capital Budgeting

        -deals with analysing the profitability and/or liquidity of a given project proposal. It is based on the following: a. funds are available

                        b. business proposals awaiting to be tapped

                        c. business opportunities that are subject to quantitative evaluation

Several projects that need capital budgeting analysis are the following:

• Replacement or expansion

• Establish a branch or not
• Purchase or lease a long-term asset
• Introduce a new product or not
• Develop a new channel of distribution or establish alliance with existing distribution channels

• Improvement or retention

• Retain the old technology or introduce a new/modern tech
• Improve channel of distribution or not

• Others

• Research and development
• Exploration
• New projects
• Internally develop a program or outsource services from available contractors

MAIN ISSUES IN CAPITAL BUDGETING

1. Net cost of investment (How much money is needed?)

-refers to the net cash outflows, after tax considerations, that are normally paid by investors in relation to the investing transaction.

Sample Problem. The World Trade Center Company plans to acquire a new equipment costing P1,200,000 to replace the equipment that is now being used. The terms of the acquisition are 3/30, n/90.Freight charges on the new equipment are estimated at P23,000 and it will cost P14,000 to install. Special attachment to be used with this unit will be needed and will cost P36,000. If the new equipment is acquired, operations will be expanded and this will require additional working capital of P250,000. The old equipment had an amortized cost P300,000 and will be sold for P180,000. If the new equipment is not purchased, the old equipment must be overhauled at a cost of P90,000. This cost is deductible for tax purposes in the year incurred tax rate is 35%. Compute the net investment in the new equipment.