Page 417 - Corporate Finance PDF Final new link

BRILLIANT’S Capital Budgeting 417

In this case, the average investment of the Bg Ho$g _|, àmoOoŠQ> Ho$ Am¡gV BÝdoñQ>_|Q> H$mo [aQ>Z©
project is taken as the base for calculating Ho$ EdaoO aoQ> H$s JUZm Ho$ {cE AmYma Ho$ ê$n _| {c`m
average rate of return which is more logical on OmVm h¡, Omo A{YH$ VH©$g§JV hmoVm h¡Ÿ&
technical ground.
Methods to Find Out the Average In- EdaoO BÝdoQ>g‘|Q> kmV H$aZo H$s {d{Y¶m§
vestment
(a) When there is no scrap value and work- (a) O~ H$moB© ñH«o$n d¡ë¶y Am¡a d{Hª$J H¡${nQ>b Zht hmo…
ing capital:
Initial Investment  Installation Charges
Average Investment =
2
(b) When there is scrap value (b) O~ H$moB© ñH«o$n d¡ë¶y hmo…

Initial Investment + Installation Charge – Scrap Value
Average Investment =
2
(c) When there is scrap value and working (c) O~ H$moB© ñH«o$n d¡ë¶y Am¡a d{Hª$J H¡${nQ>b hmo…
capital NPP

Initial Investment + Installation Charge – Scrap Value
Average Investment =
2
+ Scrap Value + Working Capital
It may be noted that the scrap value is `h Ü`mZ {X`m Om gH$Vm h¡ {H$ ñH«¡$n d¡ë`y H$mo nhbo
first deducted and later added back. The scrap KQ>m`m OmVm h¡ Am¡a ~mX _| nwZ… Omo‹S> {X`m OmVm h¡Ÿ& ñH«¡$n
value has been deducted to find out the annual
amount of depreciation. However, this amount d¡ë`y H$mo KQ>mZo H$m CÔoí` S>o{à{gEeZ H$s am{e H$r JUZm
of scrap value remains blocked in the project H$aZm hmoVm h¡ naÝVw àmoOoŠQ> H$s Ad{Y nyU© hmoZo na ñH«¡$n
and is released only at the end of the economic d¡ë`y go H¡$e H$m BZâcmo hmoVm h¡, Bg{bE Ad{Y Ho$ AÝV
life of the project, so the amount of scrap value
has been added back to find out the average _| Bgo nwZ… Omo‹S> {X`m OmVm h¡Ÿ& R>rH$ Cgr àH$ma d{Hª$J
investment. Similarly the additional working H¡${nQ>c H$mo ^r àmoOoŠQ> H$s Ad{Y nyU© hmoZo na EdaoO
capital is also released back when the project BÝdoñQ>_|Q> H$s JUZm Ho$ {bE nwZ… Omo‹S>m OmVm h¡Ÿ& AV:
is terminated. So the amount of working capi-
tal should also be added to the average invest- d{Hª$J H¡${nQ>c H$mo ^r EdaoO BÝdoñQ>_|Q> H$s JUZm Ho$ {cE
ment calculated as above. Omo‹S> {X`m OmVm h¡Ÿ&
The Decision Rule {ZU©` g§~§Yr {Z`_

The ARR calculated as above is compared ARR H$s JUZm H$aZo Ho$ níMmV² CgH$s VwbZm {aQ>Z©
with the pre-specified rate of return. If the H$s nyd© {ZYm©[aV aoQ> go H$s OmVr h¡Ÿ& `{X ARR Xa A{YH$
calculated ARR is more than the pre-specified h¡ Vmo àmoOoŠQ> H$mo ñdrH¥$V H$a {b`m Om`oJm AÝ`Wm AñdrH¥$V
rate, the project is likely to be accepted,
otherwise not. In case of various mutually H$a {X`m OmEJmŸ& EH$ go A{YH$ å`yMwAbr EŠgŠby{gd
exclusive proposals, the project with the àñVmdm| Ho$ Ho$g _| Cg àmoOoŠQ> H$mo àmW{_H$Vm Xr Om`oJr
highest ARR will have the top priority. {OgH$m ARR g~go A{YH$ h¡Ÿ&