Mr. Marlon M.

Ladesma
Capital Investment

- involves significant commitment of funds to

receive a satisfactory return (increase in revenue or
reduction in costs) over an extended period of time.
Example: Purchase of equipment for expansion,
replacement of old equipment
General Characteristics of Capital
Investment Decisions
As to Cost – usually involves large expenditure of
resources, relative to business size
As to Commitment – usually funds invested are tied up
for a lone period of time.
As to Flexibility – usually more difficult to reverse than
short-term decisions
As to Risk – usually involves so much risks and
uncertainties due to operational and economic changes
over an extended period of time
Capital Budgeting

It is the process by which management identifies,

evaluates and makes decision on capital investment
projects of an organization. It is the process of planning
expenditures for assets, the return on which are expected
to continue beyond one year period.
Capital Budgeting Techniques
2 Methods of Capital Budgeting Techniques:

Non-discounted methods – methods that do not

consider the time value of money.

Discounted methods – methods that consider the time

value of money
Non-discounting methods

1. Payback period method

2. Bail-out payback period
3. Accounting Rate of return
4. Payback reciprocal method.
Payback Period
Advantages of Payback
1. Payback is simple to understand and easy to
compute.
2. Payback gives information about liquidity of the
project.
3. It is good surrogate for risk. A quick or short
payback period indicates a less risky project.
Disadvantages of Payback
1. Payback does not consider the time value of money.
All cash received during the payback period is
assumed to be equal value of in analyzing the
project.
2. It gives more emphasis on liquidity rather than on
profitability of the project. In other words, more
emphasis is given on return of investment rather
than return on investment.
3. It does not consider the salvage value of project.
4. It ignores cash flows that may occur after the
payback period.
Bail-out Payback Period

A modified payback period method wherein cash

recoveries include the estimated salvage value at the
end of each year of the project life.
Accounting Rate of Return (ARR)

Investment may be based on original or average

investment.
Industrial Engineering Method

-Based on the relationship between inputs and

outputs in physical forms; engineering estimates
indicate what and how much cost should be.
Account Analysis Method

-Each account is classified as either fixed or

variable based on experience and judgment of
accounting ad other qualified personnel in the
organization.
Conference Method

-Costs are classified based on opinions from

various company departments such as
purchasing, process engineering, manufacturing,
employee relations and so on.
Correlation Analysis
- It is used to measure the strength of linear
relationship between two or more variables. The
correlation between two variables can be seen by
drawing a scatter diagram:

- If the points seem to form a straight line, there is a

high correlation.

- If the points form a random pattern, there is a low

correlation or no correlation at all.
Coefficient of Correlation (r)
- Measures the relative strength of linear relationship
between 2 variables. The range of the coefficient “r”
is from -1.0 to +1.0.
- If r = -1.0, there is a perfect inverse linear relationship
between 2 variables.
- If r = 0, no linear relationship.
- If r = +1.0, there is a perfect direct relationship
between X and Y.
Coefficient of Determination (r2)
- It is the proportion of the total variation in Y that is
explained or accounted for by the regression
equation, regardless of whether the relationship
between X and Y is direct or inverse. It is the measure
of “goodness of fit” in the regression. The higher the
r2, the more confidence one can have in the
estimated cost formula.
Balance Scorecard
- It is an approach to performance measurement that
combines traditional financial measures with non-
financial measures.

There are four (4) perspective of balance scorecard.

1. FINANCIAL perspective
2. CUSTOMER perspective
3. LEARNING & GROWTH perspective
4. INTERNAL BUSINESS PROCESSES perspective
Financial Perspective

- Measures reflecting financial performance.

Examples: profit, return on investment (RoI),
revenue growth
Customer Perspective

- Measures having a direct impact on customers.

Examples: customer satisfaction, customer retention,
market share, customer complaints
Learning & Growth Perspective

- Measures describing the company employee’s

learning curve. Examples: employee satisfaction,
employee turnover, training and recreation.
Internal Business Processes
Perspective

- Measures showing key business processes

performance. Examples: manufacturing cycle
efficiency, product quality, productivity measures,
throughput
Components of Balanced Scorecard
Strategic Objectives – a statement of what strategy
must achieve and what is critical to its success.
Strategic Initiatives – key action programs required to
achieve strategic objectives.
Performance Measures – describe how success in
achieving the strategy will be measured.
Baseline Performance – the current level of
performance measure.
Targets – the level of performance or rate of
improvement needed in the performance measure.
-end-