Question

list capital decisions methods and explain the criteria of accepting or rejecting capital projects under the net present value method .

Answer 1

Solution:

Capital budgeting refers to the decision making process related to long-term investment proposals. The various techniques followed in asceratining the feasibility of the investment are

1. Pay Back period

2. Average rate of return

3. Net Present Value

4. Internal rate of return and

5. Profitability Index

Net Present Value method takes into account the time value of money associated with the proposal. It discounts all the cash inflows and cash outflows the project brings in. NPV is the difference between all discounted cash inflows and discounted cash outflows.

Net Present Value (NPV) = Present value (PV) of Inflows – Present value (PV) of outflows

The project will be worthy of consideration only when the NPV is a positive figure. It follows a simple rule: If NPV is positive accept the project and if the NPV is negative reject the project (for independent projects). When there are two or more projects (mutually exclusive projects) for consideration the projects having the higher NPV will be opted for.