🔍
Capital Budgeting: Basic Concepts【Deric Business Class】 - YouTube
Channel: unknown
[3]
[Music]
[6]
hey guys
[7]
welcome to derek business class in this
[9]
video
[10]
i'm gonna explain to you the basic
[12]
concepts of capital budgeting
[16]
capital budgeting is the process of
[18]
identifying
[19]
evaluating and implementing firms
[21]
investment opportunities
[23]
let's say now you have one million
[26]
dollars
[26]
and three potential investments are
[28]
being presented to you
[30]
the process of deciding which project to
[32]
invest is what we call
[34]
capital budgeting capital budgeting has
[37]
got a few indicators
[38]
such as payback period npv irr
[42]
to assist us to select the best
[44]
investment for the company
[46]
through the analysis of potential
[48]
additions to fixed assets
[50]
take note of the keywords fixed assets
[53]
when you do capital budgeting you are
[56]
basically considering investing in fixed
[58]
assets
[59]
such as buying machines or equipments it
[62]
seeks to identify investments that will
[64]
enhance a firm's competitive advantage
[66]
and increase shareholder wealth
[68]
investing in the fixed assets
[70]
in fact is to enhance the firm's
[72]
competitive advantage
[74]
competitive advantage is an attribute
[76]
that enables a company to perform better
[79]
than its competitors
[80]
to increase shareholder wealth is the
[82]
same as to increase the share price or
[85]
the value of the company
[86]
it is in line with the goal of
[88]
shareholder wealth maximization
[91]
capital budgeting deals with long-term
[93]
decisions which involves large
[95]
expenditures
[96]
for committing a large sum of spending
[98]
the company has to be very cautious
[101]
for the calculation two parts we are
[104]
gonna deal with
[105]
first we have to estimate the amount of
[108]
initial investment
[109]
second the future cash inflows that
[112]
could be received
[113]
that is what we call cost and benefits
[115]
analysis
[118]
next the capital budgeting process
[120]
consists of five steps
[122]
first estimate cash inflows and outflows
[126]
second assess the riskiness of cash
[129]
flows
[130]
third determine the appropriate cost of
[132]
capital
[133]
wacc fourth find the npv and irr
[139]
lastly accept the investment if the npv
[142]
is greater than zero
[143]
or the irr is greater than the wacc
[147]
we will explain more later in the
[148]
following slides
[151]
before showing you the calculation part
[153]
there are some basic concepts we have to
[155]
explain
[156]
first the first one is to differentiate
[159]
the basic terminology
[160]
independent projects versus mutually
[162]
exclusive projects
[164]
we have two types of projects the first
[167]
one is independent projects
[170]
independent projects mean the acceptance
[172]
of an investment does not preclude the
[174]
acceptance of other investments
[176]
so accepting one project will not affect
[179]
the decision of accepting another
[181]
project
[182]
basically because the two projects do
[185]
not compete for the firm's resources
[188]
as long as the investments meet the
[190]
relevant capital budgeting criterion
[192]
all investments could be accepted
[195]
however
[195]
mutually exclusive projects mean the
[198]
acceptance of an investment would
[200]
automatically lead to rejection of other
[202]
investments
[203]
let's say you have five potential
[205]
projects if these projects are mutually
[207]
exclusive
[208]
you can only choose to accept one out of
[211]
the five
[212]
projects mutually exclusive projects are
[215]
the investments that compete in some way
[217]
for a company's resources
[219]
in other words due to the capital
[221]
constraints of the company
[223]
such projects cannot be undertaken
[225]
simultaneously
[227]
therefore only one investment could be
[229]
undertaken at a particular time
[232]
all right another comparison is and
[235]
limited funds versus capital rationing
[238]
if the firm has unlimited funds for
[240]
making investments
[242]
then all independent projects that
[244]
provide returns greater than some
[245]
specified level
[247]
can be accepted and implemented but
[250]
unlimited fund is something not true
[252]
it's impossible that the company may
[254]
have unlimited fund
[255]
no matter how big the company is that's
[258]
why we say
[259]
in most cases firms face capital
[262]
rationing restrictions
[263]
since they only have a limited amount of
[265]
funds to invest in potential investment
[268]
projects at any given point of time
[270]
limited amount of funds is the capital
[272]
constraint
[274]
in short capital rationing is the act of
[276]
placing restrictions
[278]
on the amount of new investments or
[280]
projects undertaken by a company
[283]
next accept reject approach versus
[286]
ranking approach
[288]
the accept reject approach involves the
[290]
evaluation of capital expenditure
[292]
proposals
[293]
to determine whether they meet the
[295]
firm's minimum acceptance criteria
[297]
projects will be evaluated one by one
[300]
separately
[301]
during the selection process however
[304]
the ranking approach involves the
[306]
ranking of capital expenditures on the
[308]
basis of some predetermined
[310]
measure such as the rate of return all
[313]
the projects returns will be ranked from
[315]
the highest to the lowest
[318]
next conventional cash flow versus
[320]
non-conventional cash flow
[323]
conventional cash flows are cash flows
[325]
which contain one cash outflow in the
[327]
initial stage
[328]
then followed by a series of cash
[330]
inflows
[331]
the sign only changes once in other
[334]
words
[335]
at the initial year you pay to invest
[337]
afterwards
[338]
you will receive cash inflows however
[342]
non-conventional cash flows are where
[344]
the cash flows sign changes more than
[346]
once
[347]
so you'll have more than one negative
[349]
cash flow
[350]
after year zero for example you pay at
[354]
year
[354]
zero then year one you will receive
[357]
positive cash flow
[358]
but you will pay again at year two that
[361]
is the negative cash flow
[363]
then from year three onwards you will
[365]
receive
[366]
positive cash flows continually for the
[369]
following calculation part
[370]
mostly we will deal with conventional
[372]
cash flows
[375]
decision making criteria and capital
[377]
budgeting
[378]
the ideal evaluation method should
[381]
include all cash flows that occur during
[383]
the life of the project
[385]
take note all cash flows consider the
[388]
time
[388]
value of money which means the timing of
[391]
cash flows
[393]
incorporate the required rate of return
[395]
on the project
[396]
required rate of return in short
[399]
required return
[400]
is the minimum return that company
[402]
should earn we are not going to accept
[404]
any project
[406]
that has a return which is lower than
[407]
the required return
[410]
all right that's all for this video
[413]
thanks for watching
[415]
see you in the next one bye
Most Recent Videos:
You can go back to the homepage right here: Homepage