Learning Objective• Given the concepts of Decision Analysis,

Option Pricing and Investment Decisions, the trainee will be able to audit the capital budgeting proposals of projects and critically examine the decisions of management as evaluated by the instructor

Three stages of capital budgeting

• Decision Analysis

• Exploring the options

• Investment decision

Decision Analysis• Multiple Attribute Decision Model

(MADM)

Cost of the project

Risk assessment

Rate of inflation

Operating costs

Capacity utilisation

Overheads

Demand forecast

Market research

Life cycle of the project

Disposal value

Advantages

• Consideration of financial and non-financial criteria

• Judgements and assumptions and its impact

• Important factors are weighed more

• Collective decision

Option Pricing

• Three common sources of options

– Timing option

– Abandonment options

– Growth options

Investment decision

• Importance of Time value of money

– Inflation

– Uncertainty

– Opportunity costs

• Calculation of discounted cash flow

Economic criteria

• Net Present Value (NPV)

• Internal Rate of Return (IRR)

• Discounted Pay Back (DPB)

Risk Analysis

• Different levels of risks between projects

• Risks specific to foreign projects

• Comparing the actuals with estimates during execution of the projects