CAPITAL EXPENDITURE AND EVALUATION TECHNIQUES

PRESENTED TO ; SARDAR RAHAT AZEEM

PRESENTED BY;

M.ADNAN SHAFIE
M. AYAZ

ANALYSIS OF FINANCIAL STATEMENT

CAPITAL EXPENDITURE
Capital Expenditures (Capex) are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset with a useful life.

EXAMPLES
Acquiring fixed, and in some cases, intangible assets Repairing an existing asset so as to improve its useful life Upgrading an existing asset if its results in a superior fixture Preparing an asset to be used in business Restoring property or adapting it to a new or different use Starting or acquiring a new business

EVALUATING TECHNIQUES
Payback Period. Accounting Rate of Return or Return on Investment. Internal rate of return. Net present value.

Payback Period.
This is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow.

Payback Period.
Principle: How fast can I recover my initial investment? Method: Based on the cumulative cash flow. Weakness: Does not consider the time value of money

EXAMPLE
Company ABC is planning to undertake a project requiring initial investment of Pkr.100 million. The project is expected to generate 25 million per year for 10 years. Calculate the payback period of the project? Solution Payback Period = Initial Investment / Annual Cash Flow = 100M / 25M = 4 years

Return On Investment
A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. Formula ROI= net profit / cost of investment *100

EXAMPLE
An investor buys 1,000 worth of stocks and sells the shares two years later for 1,200. The net profit from the investment would be 200 and the ROI would be calculated as: ROI = (200 / 1,000) x 100 = 20%

Internal rate of return

IRR is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero.

IRR
Internal rate of return is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a companys required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected.

Net Present Value (NPV)

Net present value is the present value of an investment's expected cash inflows minus the costs of acquiring the investment. The formula for NPV is:
NPV = (Cash inflows from investment) (cash outflows or costs of investment or Intitial Cost)

Example Find the IRR of an investment having initial cash outflow of $213,000. The cash inflows during the first, second, third and fourth years are expected to be $65,200, $98,000, $73,100 and $55,400 respectively. Solution Assume that r is 10%. NPV at 10% discount rate = $18,372 Since NPV is greater than zero we have to increase discount rate, thus NPV at 13% discount rate = $4,521 But it is still greater than zero we have to further increase the discount rate, thus NPV at 14% discount rate = $204 NPV at 15% discount rate = ($3,975) Since NPV is fairly close to zero at 14% value of r, therefore IRR 14%

Decision rule for NPV method:

Accept a project if its NPV is positive when the projects Net Cash Flows are discounted at the required rate of return.

NPV Example
Example:
Investment of PKR. 9000. Net cash flows of PKR. 5090, PKR. 4500 and Pkr.4000 at the end of years 1, 2 and 3 respectively. Assume required rate of return is 10% p.a. What is the NPV of the project?

 NPV: CF +CF2nd Year + CF

(1+K) (1+K)

3rd Year

(1+k)

= 5090 + 4500 + 4000 - 9000 1.10 1.10 1.10 =4627+3719+3005 9000 =2351 Thus, using a discount rate of 10%, the projects NPV = +PKR 2351 > 0, and is therefore acceptable.