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CAPITAL EXPENDITURE BUDGETING (Methods of Project Appraisals (Time value…
CAPITAL EXPENDITURE BUDGETING
Capital expenditure budgeting
Capital and revenue income
RI : sales of trading assets
CI : disposal of NCA
NCA : asset used in the buiness operations>1 year to generate income
Capital and revenue expenditure
RE : for the purpose of trade of the business
CE : acquisition of NCA/ improvement in earning capacity
Self-constructed assets
Business builds its own non-current assets
Relevant and Non-Relevant Costs
Relevant costs
Future cash flow arising as direct consequence of a decision
Differential cost
Opportunity costs
Avoidable cost
Non-relevant costs
Irrelevant for decision making
Commited cost
Notional costs
Sunk cost
Methods of Project Appraisals
Nominal rates of interest
interest rate expressed as per annum figure
Payback period
Time taken for the initial cash outflow to be recovered in the cash inflows from the project
Time value of money
Discounting interest
P = S/(1+r)^n
Compounding interest
S=P(1+r)^n
Effective annual rate of interest
Corresponding annual rate when interest is compounded at intervals shorter than a year
(1+R) = (1+r)^n
Discounted cash flow DCF
Net present value
calculates the present value of cash flows and sums them to get NPV
if NPV is positive, project is acceptable
Internal rate of return
trial and error method to disccover the discount rate
when NPV = 0
Project is worth taking if IRR > cost of capital