CAPITAL BUDGETING

Payback period
Traditional
Accounting Rate of Return
Capital Budgeting Net Present Value
Discounted Cash Flow Method Internal Rate of Return
Profitability Index

Payback period Number of years to recover initial cost

If payback period is less than the maximum acceptable payback period,
accept the project
Decision criteria
If payback period is greater than the maximum acceptable payback period,
reject the project

Net Present Value NPV = (PV of Cash Inflow – Initial Investment)

If NPV > $0, accept the project
Decision criteria
If NPV < $0, reject the project

Internal Rate of Return Discount rate that equate the NPV of an investment with $0
If the IRR is greater than the cost of capital, accept the project
Decision criteria
If the IRR is less than the cost of capital, reject the project

Independent Project All Projects which meet the Capital Budgeting criterion should be
accepted
Mutually Exclusive Set of projects from which at most one will be accepted
Project
Q#01 Jordan Enterprises is considering a capital expenditure that requires an initial investment
of $42,000 and returns after-tax cash inflows of $7,000 per year for 10 years. The firm has a
maximum acceptable payback period of 8 years. Determine the payback period for this project.
Q#02 General Electric is attempting to evaluate the feasibility of investing $95000 in a piece of
equipment that has a 5 year life. The firm has estimated the cash inflow associated with the
proposal as shown in the following table. The firm has a 12% cost of capital.
Years Cash Inflows $
1 20000
2 25000
3 30000
4 35000
5 40000
a. Calculate the payback period for each project.
b. Calculate the net present value (NPV) of each press.
c. Calculate the IRR.
Q#03 Shell Camping Gear, Inc., is considering INDEPENDENT PROJECTS. John Shell, president of
the company, has set a Maximum payback period of 4 years and 9% cost of capital.
Initial investment of project-A $500000 & Project-B $325000.The after-tax cash inflows
associated with each project are as follows

Cash Inflow $
Year Project –
Project-B
A
1 100000 140000
2 120000 120000
3 150000 95000
4 190000 70000
5 250000 53000
a. Calculate the payback period for each project.
b. Calculate the net present value (NPV) of each press.
c. Calculate the IRR.

Q#04 Company considering two MUTUALLY EXCLUSIVE PROJECTS, using a 12% cost of capital.
Which project, on this basis, is preferred? Estimated cash flow is shown in the following table.

Project A Project B
Initial investment (CF0 ) 130000 85000
YEAR CASH INFLOW $
1 25000 40000
2 35000 35000
3 45000 30000
4 50000 10000
5 55000 3000

a. Calculate the payback period for each project.

b. Calculate the net present value (NPV) of each press.
c. Calculate the IRR.