Question

1. This week we discuss capital budgeting methods and processes. Could you apply the knowledge you learn this week to make better decisions in your personal life or professional duties? Please elaborate on your answer with examples.

Answer 1

the capital budgeting process helps us both in professional and personal lives. it is nothing but taking a rational decision with the help of time value of money concept in finance.

Assume you have got a job in another city and you wanted to move there. you need a place to stay there. there are two options available - Either renting a place or Owning a place.

With the help of capital budgeting process you can compute the NPV of both these options and can decide. Basically the factors like percentage of income you pay for rent if you are renting, what is the cost of same property if you own it, are there any tax benefits, how long you are going to stay there, what is the expected appreciation on the property etc.

Below is the snap shot of calculations. Assume a person moving to a new city for work, and assume he stays there for 5 years. the details are mentioned in the snap shot. The cost of buying the similar property is INR 50 Lakhs, for which there is a down payment of INR 20 Lakhs is required and the remaning amount INR30 Lakhs is financed through a home loan at 8% rate of interest. the EMI per month comes to INR 60829. There is cost price of 6% associated with buying the house.

For simplicity, assume the house price after 5 years is INR 60 Lakhs. And the selling cost is 1%.

Also assume he opts for renting the property, the cost of rent is INR 25000 per month and assume it is fixed for 5 years. Also, if he opts for renting out, he has the down payment amount saved and assume he keeps in a bank FD which pays him 4% interest rate p.a. This means he will get INR 80000 per annum. Also there is terminal value of INR 20 Lakhs at the end of 5 years.

Below is the NPV, if he opts to buy the house.

Below is the NPV Computation if he opts to rent the house.

Since the NPV is more for renting he should prepfer to rent the house. This may change if he stays for more than 5 years or the rent increases every year or if the mortagae cost is low etc.

So by using capital budgeting process, any decision could be taken rationally either on personal front or on professional front,