Module Code and Title:   FIN304 Capital Budgeting

Programme:                          Bachelor of Commerce

Credit Value:                         12

Module Tutor:                       Tirtha Raj Puri, Gagan Mongar, Ritu Barna  Adhikari, Madhav Verma, Kabita Chhetri

Module Coordinator:            Gagan Mongar

General objective: The objective of the module is to acquaint students with the process of capital budgeting and project evaluation techniques. Students will be able to forecast project cash flows and the cost of capital. Students will also be able to use optimal operating policy of investment decision in response to various risk which may be inherent in these decisions. The module further aims to provide students with the skill of selecting lease of asset compared to buying the asset.

Learning outcomes – On completion of the module, learners should be able to:

1. Prepare financial forecasts for capital costs, operating costs, operating revenues and cash flows for designated capital budgeting decisions.
2. Apply different investment techniques such as PBP, ARR, NPV, PI, IRR, and Discounted PBP to make investment decisions.
3. Estimate project risk using different techniques and adjust it in payback period, discount rate, and cash flows for investment decision.
4. Assess the sensitivity of a project’s net present value to changes in assumptions and potential environments
5. Evaluate lease vs buying decisions for different businesses.
6. Compute the borrowing cost in asset buying decision and compare it with lease.
7. Calculate the weighted average cost of capital and use this for investment decisions.
8. Forecast the capital required for buying assets.
9. Anticipate the impact of high and low leverage and select appropriate sources of finance.

Teaching and Learning Approach:

Assessment Approach:

1. Project and Presentation: Portion of Final Marks: 20%

Student groups of 4 will select and analyse a financial project using techniques taught in class to forecast financial needs and obtain funding. The project will be approximately 1000 words, and include problem definition, data collection, financial analysis, conclusions and references. The group presentation will be approximately 10 minutes, and include power points slides. 

Report assessment criteria (15%)

2%       clear definition of a problem

3%       using appropriate financial techniques

2%       gathering data and information from financing sources

4%       Recommendations and conclusions

4%       individually assessed process score (contribution to the group output)

Presentation assessment criteria (5%)

1%       presentation skills

2%       ability to clearly disseminate the project idea/information

2%       sufficient response to the questions asked

1. Assignments: Portion of Final Marks: 10%

Each student will complete a written assignment applying financial techniques to evaluate Lease Vs Buying decisions. The assignment will be within the word limit of 1000-2000 words.

4%       evaluation of alternatives

2%       using the correct procedure

2%       documenting correct conclusions

2%       explaining the business implications of the results

1. Case Study (Group work): Portion of Final Mark: 20%

Each group of 4 will discuss 2 cases studies. The students will be required to present the case in the class. Each case will be assessed out of 10%.

Marking Criteria

Identification of the problem addressed in the case study – 2%

Analysis and findings – 3%

Overall presentation – 2%

Q & A – 3%

1. Midterm Examination: Portion of Final Mark: 15%

Students will take a written exam of 2 hours duration covering topics up to the mid-point of the semester.

1. Semester-End Examination: Portion of Final Marks: 35%

The module will have a semester-end exam for 2 hours covering the entire syllabus. The question will be divided into two parts – Part A (carrying 40% of the exam weightage) will be mostly of short answer including objective questions. Part-B (carrying almost 60% of the exam weightage) will be mostly of essay type or an extended response to the given question. This part of the question requires students to apply, analyse, and evaluate or construct knowledge and skills. Cases will also be used to test the levels of knowledge.

Pre-requisites: FIN201 Fundamentals of Corporate Finance

Subject matter:

1. Introduction to Capital Budgeting
   • Objective of capital budgeting
   • Capital budgeting principles and criteria
   • Steps in capital budgeting decisions
   • Classifying capital budgeting projects

2. Estimating Project Cash Flows
   • Incremental versus total cash flows
   • The replacement problem
     • Estimating initial investment
     • Estimating operating cash flows
     • Estimating the terminal value
   • The new product introduction decision
     • Estimating initial value for new product introduction
     • Estimating terminal value for new product introduction

3. Capital Budgeting Evaluating Techniques
   • Investment appraisal criteria
     • Non-discounted cash flow techniques
       • Payback period
       • Accounting rate of return
     • Discounted cash flow techniques
       • Net present value
       • Internal rate of return
       • Modified Internal rate of return
       • Profitability index
       • Discounted payback period
       • Acceptance and Rejection rule for the techniques

4. Lease Vs Buy decisions
   • Basic concept of Lease and Cash Flows specific to lease
   • Types of Lease: Financial and Operating lease
   • Lease Vs Buying decision
   • Effect of borrowing in buying Vs Lease decision

5. Capital Budgeting and Risk
   • Measurement of project risk
     • Project risk
     • Firm risk
     • Systematic risk
   • Sensitivity analysis
     • Break-even analysis
   • Simulation analysis
     • Problems with simulation analysis
     • Survey of risk assessment techniques used in practice
   • Adjusting for project risk
     • Adjusting the payback period
     • Adjusting the discount rate
     • Adjusting cash flows
     • Using certainty equivalents
     • Survey of risk adjustment techniques used in practice
   • Decision trees

6. Estimating the Project Cost of Capital
   • Risk and the cost of capital for a project
     • The capital asset pricing model
     • Financial structure and appropriate discount rates
   • The cost of capital for the firm
     • The cost of equity capital
     • The cost of debt capital
     • The cost of preferred stock
     • Calculating weighted average cost of capital
   • The cost of capital for a decision
     • Assessing weighted average cost of capital
     • Adjusted present value
     • Levered equity method
     • Comparing the WACC, APV, and LE methods

7. Sources of Funds
   • Capital and Capital Structure
   • Effect of Leverage in Capital structure
   • Sources of funds: Equity, Preference shares and Debt
   • Venture Capital (VC): Stages of VC funding
   • Private Equity

Reading List:

1. Essential Reading

• Sharpiro, A.C. (2008). Capital budgeting and investment analysis. India: Pearson Education, Inc.
• Peterson, P.P., & Fabozzi, F.J. (2002). Capital budgeting: Theory and practice. United States of America: John Wiley & Sons, Inc.
• Bierman, H. J. & Smidt, S. (2006). The capital budgeting decisions: Economic analysis of investment projects, (9^th ed). Routledge.

2. Additional Reading

• Ross, S.A., Westerfield, R.W., & Jordan, B.D. (2012). Fundamentals of CorporateFinance, (9^th). McGraw Hill, New Delhi.
• Pandey, I.M. (n.d.) Financial Management and Policy (10^th ed). Vikas Publication, New Delhi.
• Dayananda, D., Irons, R., Harrison, S., Herbohn, J. & Rowland, P. (n.d.). Capital Budgeting: Financial appraisal of investment projects. Cambridge University Press.

Date: July, 2017