Page 60 - IMDR MSME BOOK 2021

Managing Finance in Micro, Small & Medium Enterprises
Various Techniques of Capital Budgeting are explained
below:

1.Pay Back Period – This technique calculates the time
in which the investment can be recovered by the
businesses. For businesses lacking liquidity, this is the
best method, as apart from returns, the time to recover
the investment matters most. Sooner the recovery, the
better the alternative is. Pay Back Period is calculated as
– Initial Investment/ Annual inow

2.NPV – This method uses the discounting of cash ows,
to compensate for the ination. NPV is the difference
between Present value of cash inows – Present value of
cash outows. This method requires a reasonable
discounting rate applicable to company/industry.

3.IRR – Internal Rate of return. This technique uses the
present value of cash inows & outows, similar to NPV.
IRR is the rate at which NPV becomes zero. The project
with a higher IRR is selected. IRR is generally calculated
by Trail & error method by keeping the NPV zero.
4.ARR – Accounting rate of return is a technique of
calculating the protability of the alternative by dividing
average prots by the initial investment. It does not take
care of the time value of money. The formula for ARR is =
Average Annual Prots/ Initial Investments.
Capital budgeting involves choosing projects that add
value to a rm. The capital budgeting process can involve
almost anything including acquiring land or purchasing
xed assets like a new truck or machinery. Capital
budgeting techniques are the methods to evaluate an
investment proposal in order to help the company decide
upon the desirability of such a proposal. In the present
study it is found that 46% of the respondent rms have
been using the prescribed techniques to take the capital
expenditure decisions. It implies that there is a lack of