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Finance sources; capital budgeting steps; NPV

Short answer

Sources are equity (ordinary shares, IPO, retained earnings), quasi-equity (preference shares, convertible debentures), long-term debt (bank, syndicated loans, bonds), government and donor funds, and others such as leasing and PPP/BOT. Capital budgeting steps are identify, screen, estimate cash flows, evaluate, select, implement, monitor, and post-audit. NPV is present value of inflows minus outflows discounted at the cost of capital; accept if NPV is positive.

Write down the sources of project financing. Explain the steps of the capital budgeting process. Discuss net present value (NPV) used in capital budgeting decision.

Sources of project financing

TypeSources
EquityOrdinary shares, sponsors' equity, retained earnings, public issue (IPO)
Quasi-equityPreference shares, convertible debentures
Debt (long term)Bank and financial institution loans, debentures/bonds, syndicated loans, term loans
Government / donorsGovernment grants and budget, soft loans from ADB, World Bank, JICA, Exim banks, bilateral aid
OthersSupplier's credit, leasing, venture capital, public-private partnership (PPP), build-operate-transfer (BOT), community and user contribution, remittance/pooled funds

Steps in the capital budgeting process

  1. Identification of investment opportunities: generate project ideas (new product, replacement, expansion).
  2. Screening and preliminary evaluation: reject unsuitable ideas.
  3. Estimation of cash flows: estimate initial cost, annual inflows, outflows and salvage value.
  4. Evaluation: apply techniques (payback, ARR, NPV, IRR, PI).
  5. Selection and approval: choose the best project(s) under budget; top management approves.
  6. Financing and implementation: arrange funds, plan and execute.
  7. Monitoring and control: compare actual with forecast and take action.
  8. Post-audit (review): check the results and learn.

Net present value (NPV)

Net present value (NPV) is the difference between the present value of all cash inflows and the present value of all cash outflows, discounted at the required rate of return (cost of capital).

NPV=∑t=1nCFt(1+k)t+S(1+k)n−I0NPV = \sum_{t=1}^{n}\frac{CF_t}{(1+k)^t} + \frac{S}{(1+k)^n} - I_0

where CFtCF_t is net cash flow in year tt, kk is the discount rate, SS is salvage value and I0I_0 is the initial investment.

  • Decision rule: accept if NPV > 0; reject if NPV < 0; for mutually exclusive projects choose the highest NPV.
  • Advantages: considers the time value of money, all cash flows and the size of the project; gives the gain in money terms; additive.
  • Limitations: needs a correct discount rate; harder to explain; ranking can be misleading for projects of different size and life.

✓ Answer checked by Claude Opus 5.5 (high effort)

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