Vinu: Manu, when a company plans a major investment, how should finance executives evaluate it?

Manu: Through capital budgeting, Vinu. The goal is simple—invest ₹1 today only if it creates more than ₹1 in value tomorrow.

Vinu: Let’s start with NPV. What does it actually tell us?

Manu: Net Present Value (NPV) measures value creation. Suppose a project requires ₹2 crore investment and generates discounted cash inflows of ₹2.5 crore.

NPV = ₹50 lakh. That means real value addition of ₹50 lakh—so it’s a good decision.

Vinu: And if NPV is negative?

Manu: Then the project destroys value. Even if it shows accounting profit, it’s not worth investing.

Vinu: What about IRR?

Manu: Internal Rate of Return (IRR) is the return the project generates. If IRR is 18% and the company’s cost of capital is 12%, the project is financially attractive.

Vinu: So IRR is like comparing returns?

Manu: Exactly. But don’t rely on IRR alone—NPV is more reliable for decision-making.

Vinu: Where does Payback Period fit in?

Manu: It measures how quickly the investment is recovered. If a ₹2 crore project generates ₹50 lakh annually, payback is 4 years.

Vinu: That sounds simple. What’s the limitation?

Manu: Payback ignores returns after recovery and doesn’t consider time value of money. It’s useful for liquidity assessment, not profitability.

Vinu: How should executives use all three together?

Manu: Use NPV to check value creation

Use IRR to compare returns

Vinu: What’s a common mistake businesses make?

Manu: Approving projects based on intuition or short payback, ignoring long-term value.

Manu: Capital budgeting is about disciplined investment.

Always ask—Is this project creating value, generating adequate return, and recovering cash within an acceptable time?

To learn more about Banking & Financial related topics

Manu: Exactly. Smart investments build strong businesses.

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