Capital Budgeting of AB Bank Ltd. (2006-2009)

Capital Budgeting:

Capital budgeting (or investment appraisal) is the planning process used to determine whether an organizations long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures.

Importance of Capital Budgeting: Such decision affects the profitability of a firm. Capital investment decision has its long time effects rather than short time effect. One can make a decision whether to invest a particular project or not. It helps to make a correct investment decision.

Capital Budgeting Techniques:Three widely used methods are used to evaluate the long term investment decision of a company: 1) Payback Method 2) Net Present Value (NPV) 3) Internal Rate of Return (IRR) 4) Profitability Index (PI)

Payback Method:

The number of years needed to recover the initial cash outlay.

Payback

Answer: Less then one year. Interpretation:In 2006 there intial outflow was 2871116872 but during the year or 2007 there inflow was 6738242780. That was more then there outfolw or investment. As a banking sector they preformed well and they increase the infolw by there investment.

Net Present Value (NPV):

NPV is the present value of an investment projects net cash flows minus the projects initial cash outflow.

CF1 CF2 CF3 + + ICO 1 2 (1 + r ) (1 + r ) (1 + r )3

=

+

+

-2871116872

=6125675255 + 6273319455 + 7101209934 -2871116872=17378885243

Interpretation:As a Bank they has good NPV and they also get higher then there investment. There net present value of money is higher then the investment. NPV mainly consider as the value of money on the investment time. AB Bank Ltd. has a good NPV during the fiscal year 2006-2009. And also they has positive NPV, it means they has good investment decision for long term.

Internal Rate of Return (IRR):IRR is the discount rate that equates the present value of the future net cash flows from an investment project with the projects initial cash outflow.

ICO=

CF1 (1 + IRR )1

+

CF2 (1 + IRR) 2

+

CF3 (1 + IRR ) 3

PV@8%:

+

+

=6239113685 + 6507815964 + 7503072466 =20250002115

PV@13%:

+

+

=5963046708 + 5944644483 + 6550509442

=18458200633

(1) PV@8% 20250002115 PV@13% 18458200633 1791801482 PV@8% 20250002115 Outflow 17378885243

(2) 2871116872

IRR=

( PVatlowerrate PVCO ) XchangeR changeinPV

Or, =.5649 =56.49%

Interpretation:There internal rate of return is very much higher then we assume. They have 56.49% of IRR that is so high. AB Bank has more then dabble return rate. During the year 2006-2009 they get more return then they invested. It is well for a company for there capital budgeting.

Profitability Index:It is sometimes called Benefit Cost Ratio or present value index. It is calculated by taking the present value of cash inflows divided by the present value of cash outflows. The decision criteria are to accept project with a Profitability Index (PI) greater than one.

=

+

+

= =67.91

Using this criterion, projects will be ranked from the one with highest PI down to one with the lowest, and then project would be

selected in the order of ranking up to the point where the budget is exhausted.