1. Basics of financial management Chapter 5

2. Capital budgeting budget
Sum total of investments in interrelated fixed and current assets Characterised by: Cashflows Receipts - expenditure

3. Calculating cash flow At start of project Cashflow = -investments
Cashflow = accounting income + depreciation
During project
Cashflow = accounting income + depreciation + residual value
In the final year

4. Assessment of capital budgeting projects
Average book rate of return
On the basis of profitability
Pay back period
On the basis of cash flow
Net present value
Internal rate of return
Taking into account the time value of money

5. Average book rate of return
Average annual profit
ABR =
Average invested capital
Ignores time value of money
Disadvantage

6. Pay back period
Time it takes a project to recover its initial investment from the cumulative cash flow
Only partly takes into account the time value of money
Does not calculate profitability
Disadvantages

7. Cumulative cash flow
Time
Start of
project

8. Criteria that take into account the time value of money
Discount rate whereby the present value of the expected cash flows equals the initial investment
Internal rate of return > weighted average cost of capital  project acceptable
Internal rate of return
Present value of the expected cash flows
NPV > 0  project acceptable
Net present value

9. Interest calculation methods
Simple interest
Interest calculated on the initial amount only
Compound interest
Interest calculated on the total initial amount and on the accumulated past interest

10. Characteristics of assessment criteria
ABR
Pay back period
NPV
IRR
Measures profitability
Yes No
Takes into account the time value of money
Limited
Suitable for assessment of accepting project
Suitable for selection of best project

11. Leasing Nature of agreement Rent Finance Lifetime
Financial lease
Finance
Lifetime of asset
Lessee
Lessor
Operational lease
Rent
< Lifetime of asset
Nature of agreement
Lifetime
Economic ownership
Legal ownership
On balance sheet