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440 Corporate Finance BRILLIANT’S

investment opportunities and set priorities is H$aZm VWm àm`mo[aQ>rO goQ> H$aZo Ho$ {bE CÝh| \$mog© H$aZo
to put upper limits to their capital expenditure. H$m EH$ VarH$m CZHo$ H¡${nQ>b EŠgnopÝS>Ma Ho$ {bE Ana
Similarly, a company may put investment {b{_Q> aIZm h¡Ÿ& gmYmaUV: H$moB© H§$nZr BÝdoñQ>_|Q> {b{_Q²>g
limits if it finds itself incapable of coping with aI gH$Vr h¡ `{X dh ñd`§ H$mo VoOr go hmoVo {dH$mg Ho$
the strains and organizational problems of a VZmd VWm Am°J}ZmBOoeZb àm°ãbåg Ho$ gmW ES>OñQ> H$aZo
fast growth. _| Ag_W© nmVr hmoŸ&

Conclusion About Capital Budgeting H¡${nQ>b ~OqQ>J ‘oWS²>g H$m H$ݳbyOZ
Methods

We have discussed various methods of h‘ {d{^ÝZ H¡${nQ>b ~OqQ>J H$s ‘oWS²>g H$s MMm©
capital budgeting comparing their relative CZH$s [abo{Q>d ñQ´>oÝW VWm drH$Zog go H$aVo h¢& Bg àmogog
strengths and weaknesses. In the process,
‘| gm‘mݶV: ¶h BåàoeZ ~ZVm h¡ {H$ ’$‘© H$mo {S>grOZ
generally an impression is created that the firm
should use NPV method for decision making. ‘¡[¨H§$J Ho$ {bE NPV ‘oWS> H$m Cn¶moJ H$aZm Mm{hE&
However, most of the large companies consider hmbm§{H$ A{YH$m§e ~‹S>r H$ånZr g^r ‘oOg© H$mo H$pÝgS>a
all the measures because each one provides H$aVr h¢ ³¶m|{H$ CZ‘| go à˶oH$ {S>{gOZ ‘¡H$a H$mo {S>’$aoÝQ>
somewhat different piece of relevant inform-
ation to the decision maker. BÝ’$m°‘}eZ XoVm h¡&
Payback and discounted payback provide no~¡H$ VWm {S>ñH$mCÝQ>oS> no~¡H$ {H$gr àmoOo³Q> H$s
an indication of both the ‘risk’ and the '[añH$' VWm '{bp³d{S>Q>r' XmoZm| H$m BpÝS>Ho$eZ XoVm h¡&
‘liquidity’ of a project. If the payback period is ¶{X no~¡H$ nr[a¶S> ~hþV bm±J h¡ Vmo BgH$m ‘Vb~ h¡ {H$
long, it means the investment will be locked up
for many years and hence the project is BÝdoñQ>‘|Q> H$B© dfm] Ho$ {bE bm°H$ {H$¶m J¶m h¡ VWm àmoOo³Q>
relatively illiquid and more risky. VwbZmË‘H$ ê$n go {bp³d’$mBS> VWm A{YH$ [añH$s h¡&
NPV is important because it gives a direct NPV Bånm°Q>}ÝQ> h¡ ³¶m|{H$ ¶h àmoOo³Q> Ho$ ~o{Z{’$Q>
measure of benefit of the project. Therefore, H$m S>m¶ao³Q> ‘oOa XoVm h¡& Bg{bE NPV H$mo àm°{’$Q>o{~{bQ>r
NPV is regarded as the best single measure of H$m EH$ g~go AÀN>m ‘oOa ‘mZm OmVm h¡& IRR ^r
profitability. IRR also measures profitability àm°{’$Q>o{~{bQ>r H$m ‘oOa h¡ VWm ¶h ^r àmoOo³Q> Ho$ goâQ>r
and it also contains information about the
‘m{O©Z H$s BÝ’$m°‘}eZ aIVm h¡& ‘mZ br{OE Xmo àmoOo³Q²>g h¢
‘safety margin’ of the project. Let us consider
two projects. Project A (small) costs ` 10,000 àmoOo³Q> A (ñ‘m°b) {OgH$s H$m°ñQ> ` 10,000 VWm df© Ho$
and is expected to return ` 16,500 at the end of Am{Ia VH$ Ano{jV [aQ>Z© ` 16,500 h¡ VWm àmoOo³Q> B
one year while project B (large) costs ` 1,00,000 (bmO©) {OgH$s H$m°ñQ> ` 1,00,000 h¡ VWm df© H$s
and has expected payoff ` 1,15,500 after one Am{Ia VH$ Ano{jV [aQ>Z© ` 1,15,500 h¡& ¶{X H$m°ñQ>
year. If the cost of capital is 10%, both projects Am°’$ H¡${nQ>b 10% h¡ VWm XmoZm| n«moOo³Q> H$m ` 5,000
have an NPV of ` 5,000 and so both are similar H$m NPV h¡ Vmo Bg àH$ma NPV Ho$ nm°BÝQ> Am°’$ ì¶y go
from NPV point of view. However, if we XmoZm| àmoOo³Q> g‘mZ hþE& ¶{X h‘ ‘m{O©Z H$mo H$pÝgS>a
consider the margin, we may observe that
H$aVo h¡ Vmo h‘ XoIVo h¡ àmoOo³Q> A H$m ‘m{O©Z 39% h¡
project A has 39% margin. It means if the cash
inflow of project A decreases by 39% (39% of BgH$m AW© h¡ àmoOo³Q> H$m H¡$e âbmo 39% VH$ H$‘ hmoVm
` 16,500 is approx. ` 6,500) then also the firm h¡& (` 16,500 H$m 39% AWm©V² ` 6,500 Ho$ bJ^J)
would recover its investment of ` 10,000. On Bg àH$ma ’$‘© AnZo ` 10,000 H$mo [aH$da H$a nmVr h¡&