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Unit 2

1. What is capital budgeting?​

Capital budgeting is the process of making decisions about long-term investments. It helps a business decide where to invest money for future profits.

It includes investments in fixed assets like machinery, buildings, and equipment. It is used for projects such as business expansion and new product development.

The main objective of capital budgeting is to select profitable projects. It helps in the proper utilization of funds and business growth.

2. Explain different types of capital budgeting (PP, NPV, IARR).​

1. Payback Period (PBP)​

  • It shows how much time a project takes to recover the invested money.
  • Less time is better.

2. Net Present Value (NPV)​

  • It shows the profit earned from a project after comparing money invested and money received.
  • Positive NPV means profit.

3. Internal Rate of Return (IRR)​

  • It shows the expected percentage of profit from a project.
  • Higher IRR is better.

3. Write down the difference between​

Fixed and working capital​

Fixed CapitalWorking Capital
It is used to buy fixed assets like machinery and buildings.It is used for daily business activities.
It is invested for a long period.It is used for a short period.
It does not change frequently.It changes regularly in business operations.
It helps in starting and expanding business.It helps in running the business smoothly.
Land, machinery, furniture.Cash, raw materials, wages.

Debt and equity​

DebtEquity
Debt means borrowed money.Equity means ownership in a business.
It must be repaid after a certain time.It does not need to be repaid.
Interest is paid on debt.Dividend is paid on equity.
Lenders do not become owners of the business.Equity holders are owners of the business.
Bank loan.Shares.

Shares and debentures​

SharesDebentures
Shares represent ownership in a company.Debentures represent borrowed money of a company.
Shareholders are owners of the company.Debenture holders are creditors of the company.
Dividend is paid on shares.Interest is paid on debentures.
Shares cannot be repaid during the life of the company.Debentures are repaid after a fixed period.
Shareholders have voting rights.Debenture holders do not have voting rights.

4. Write down different financial ratios like liquidity ratio, profitability ratio, debt equity ratio and activity ratio.​

1. Liquidity Ratio​

  • It measures the ability of a business to pay its short-term liabilities.
  • Example: Current Ratio.

2. Profitability Ratio​

  • It measures the profit-earning capacity of a business.
  • Example: Net Profit Ratio.

3. Debt-Equity Ratio​

  • It shows the relationship between borrowed funds and owner's funds in a business.

4. Activity Ratio​

  • It measures how efficiently a business uses its assets and resources.
  • Example: Stock Turnover Ratio.