Capital Budgeting

Capital Budgeting 1. Project A payback calculation :( Initial Investment=$1000) Year Cash flows Cumulative CF 1 70 70 2 80 150(70+80) 3 90 240(70+80+90) 4 100 340(70+80+90+100) 5 110 450(70+80+90+100+110) 6 120 570(70+80+90+100+110+120) 7 130 700(70+80+90+100+110+120+130) 8 140 840(70+80+90+100+110+120+130+140) 9 150 990(70+80+90+100+110+120+130+140+150) (70+80+90+100+110+120+130+140+150+210) In year 9, the cumulative cash flows needs $10 more to hit the initial capital outlay of $1000.Therefore ;=( 1000-990)/150. Therefore;10/150=0..Payback Period for project A is 9.8333333 years. Payback Period for Project B Year Cash flows Cumulative Cash Flows 1 100 100 2 0 100(100+0) 3 400 500(100+0+400) 4 0 500(100+0+400+0) 5 100 600(100+0+400+0+100) 6 200 800(100+0+400+0+100+200) 7 0 800(100+0+400+0+100+200+0) 8 100 900(100+0+400+0+100+200+0+100) 9 0 900(100+0+400+0+100+200+0+100+0) In year 9, $100 more are needed to achieve a capital outlay of $1000.Therefore;1000-900=100/300=0.33333.Hence PP=9+0.3333=9.3333 years. 2. Accounting Rate of Return (ARR) ARR= (Average annual cash flows/Initial outlay) ×100 Project A average cash flows=1200/10=120 ARR= (120/1000) ×100=12% Project B average cash flows=1200/10=120 ARR= (120/1000) ×100=12% 3. Net Present Value (NPV) Project A Discounted cash flows Year Cash flows Discounting factor (1+r)-t Discounted Cash Flows 0 _ _ -1000 1 70 0.9524 66.67 2 80 0.9070 72.56 3 90 0.8638 77.74 4 100 0.8227 82.7 5 110 0.7835 86.18 6 120 0.7462 89.54 7 130 0.7107 92.39 8 140 0.6768 94.75 9 150 0.6446 96.69 10 210 0.6139 128.91 Sum of discounted cash flows=887.70