Capital budgeting is making long-run planning decisions for investment in project. Evaluation techniques of capital budgeting can be classified into two categories.
1. Traditional Methods
2. Discounted Cash Flow Methods
1. Traditional Method
Traditional method does not consider the time value of money. It assumes that present value is equal to future value. Traditional method is also known as on discounted or unsophisticated method. There are two methods of evaluation:
i) Pay Back Period (PBP)
ii) Accounting Rate Of Return (ARR).
2. Discounted Cash Flow Method
Discounted cash flow method is based on the concept of the time value of money. It is more practicable concept of decision making. The discounted cash flow method assumes that present value of any amount is not equal to future value. The present value is much more worth than future value. So, before evaluating any project, first of all the estimated cash flows must be converted into present value. To convert into present value from the future value is known as discounted value. On the basis of discounted value, it makes decision. So, it is known as discounted cash flow method. The following methods are used under discounted cash flow method:
i) Net Present Value (NPV)
ii) Profitability Index (PI)
iii) Internal Rate Of Return (IRR)
1. Traditional Methods
2. Discounted Cash Flow Methods
1. Traditional Method
Traditional method does not consider the time value of money. It assumes that present value is equal to future value. Traditional method is also known as on discounted or unsophisticated method. There are two methods of evaluation:
i) Pay Back Period (PBP)
ii) Accounting Rate Of Return (ARR).
2. Discounted Cash Flow Method
Discounted cash flow method is based on the concept of the time value of money. It is more practicable concept of decision making. The discounted cash flow method assumes that present value of any amount is not equal to future value. The present value is much more worth than future value. So, before evaluating any project, first of all the estimated cash flows must be converted into present value. To convert into present value from the future value is known as discounted value. On the basis of discounted value, it makes decision. So, it is known as discounted cash flow method. The following methods are used under discounted cash flow method:
i) Net Present Value (NPV)
ii) Profitability Index (PI)
iii) Internal Rate Of Return (IRR)
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