CHAPTER FOUR

CAPITAL BUDGETING
(The Investment Decision)
Learning Objectives

After you have covered this chapter you should be able to:
 Understand what a capital budgeting is
 Understand the different techniques to be used to make capital budgeting decision
 Explain the pros and cons of investment decision techniques.
 Understand how to make a capital budgeting decision under condition of risk and
uncertaint.

5.1. Introduction
An efficient allocation of capital is the most important finance function in the modern times. It
involves decisions to commit the firm’s funds to the long term assets. Investment decisions can
also be called as capital budgeting decision. Capital budgeting decisions may be defined as the
firm’s decisions to invest its current funds most efficiently in the long term assets in anticipations
of an expected flow of benefits over a series of years. The firm’s investment decisions would
include:
 Expansion
 Acquisition
 Modernizations
 Replacements of the long term assets.

A sale of a division or a business (divestment) is also as an investment decision. Therefore, if the

decisions have long term implications for the firm’s expenditures and benefits, they should also
be evaluated as investment decision.

Example:
 Change in the method of distribution
 Change in method of advertisement
 Change in method of research etc…

Feature of Investment decision

The following are the feature of investment decisions:
 The exchange of current funds for future benefits.
 The funds are invested in long term assets.
 The future benefits will occur to the firm over series of years.

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5.2. Importance of Investment Decisions

1. Growth: The effects of investment decisions extend in to the future and have to be
endured for a longer period than the consequences of the current operating
expenditure. A firm’s decision to invest in long term assets has a decisive influence
on the rate and directions of its growth. A wrong decision can prove disastrous for
the continued survival of the firm; unwanted of unprofitable expansion of assets will
result in heavily operating cost to the firm.

2. Risk: A long term commitment of funds may also change the risk complexity of the
firm. If the adoption of an investment increases average gain but causes frequent
fluctuations in its earnings, the firm will become more risky.
3. Funding: Investment decision generally involve large amount of funds, which make
it imperative for the firm to plan its investment programs very carefully and make an
advance arrangement for procuring finance internally or externally.
4. Irreversibility: Most investment decisions are irreversible because it is difficult to
find a market for such capital items once they have been acquired.
5. Complexity: Investment decisions are among the most difficult decisions of the
firm. There is an assessment of future events, like economic political, social,
technological etc., which are difficult to predict. They cause the uncertainty in cash
flow estimation.

5.3. Types of Investment Decision

There are many ways to classify investments:
 Expansion of existing business.
 Replacement and modernization.
 Expansion of new business.

I. Expansion of existing Business: A company may add capacity to its existing

product line to expand existing operation. Expansion of new business requires an
investment in a new product and kinds of production activity within the firm.
Sometime a company acquires existing firm to expand its business in either case the
firm make investment in expectation of additional revenue. Investment in existing
or new product may also be called a revenue expansion investment.

II. Replacement and Modernization: The main objective of modernization and

replacement is to improve operating efficiency and reduces costs. Cost saving is
reflect in the increased profit, but the firm’s revenue may remain unchanged. When

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 assets become outdated and absolute with technological change, the firm must
decide to replace those assets with new asset that operate more economically.
Replacement decision helps to introduce more efficient and economical asset called
cost reduction investment.

III. Expansion of New Business: If a company invests in a new plant and machinery to
produce a product, which the firm has not produced before, it is the expansion of
new business or unrelated diversification.

Another classification of Investment is that:

 Mutually exclusive investment

Mutually exclusive investment serves the same purpose and competes with each other. If one
investment is undertaken others will have to be excluded. Example, A company may use either
a semi-automatic machine (labor intensive) or fully automatic machine (capital intensive)
cement. Thus, choosing a semi-automatic machine precludes the acceptance of the fully
automatic machine, because the company can produce cement by using either of the two.
 Independent Investment
Independent investment serves different purpose and do not compute with each others. Example,
Dashen brewery factory may be considering expansion of its plant capacity to produce additional
bottles of beer and additional new product facility to produce soft dirk. Therefore, the decision is
depending upon the profitability and availability of funds. If there are enough funds, the factory
can undertake both investments.
 Contingent investment
They are dependent projects; the choice of one investment necessitates undertaking one or more
other investments. Example, if a company decides to build a factory in a remote area, it may
have to invest in houses for employees, roads for transportation etc.

5.4. Investment Evaluation criteria

All the investment evaluation criteria are grouped under two broad categories.
1) Discounted cash flow (DCF) criteria:
a) Discounted Pay Back Period
b) Net Present Value (NPV)
c) Internal Rate of Return (IRR)
d) Profitability Index
2) Non-discounted cash flow criteria:
a) Pay back period (PB)
b) Accounting Rate of Return (ARR)

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1. DISCOUNTED CASH FLOW (DCF) CRITERIA
A) The Discounted Payback period
 The discounted payback period is defined as the number of years that is required to
recover the amount of money invested in a project at the beginning after discounting the
future cash flows to their present values.
 The expected future cash flows are discounted by the projects cost of capital.

Acceptance rule-There is no any common standard and generally, they compare the project pay
back with predetermined standard pay back. The project would be accepted if its pay back
period is less than the maximum or standard pay back period set by management.

Example: Suppose that a given capital budgeting alternative is expected to have an initial
investment of 30,000Birr and the life of 5 years. The after-tax cash flows from the project
during years 1,2,3,4 and 5 are 15,000Birr, 18,000Birr, 12,000Birr, 20,000Birr, and 22,000Birr
respectively. The cost of capital (the required rate of return) is 10 percent. What is the
discounted payback period for this project?

Solution
Year Cash flow Discount Factor Present Value of CF Cumulative CF
1 15,000 0.909 13,635 13,635
2 18,000 0.826 14,868 28,503
3 12,000 0.751 9,012 37,515*
4 20,000 0.683 13,660 51,175
5 22,000 0.621 13,662 64,837

Payback period = year before full recovery + unrecovered cost /

Annual cash inflow during the next year
Discounted Pay back period = 2 years + (1,497/9,012) years
= 2 years + 0.17 years = 2.17 years
Or
= 2 years + (0.17) (12 months)
= 2 years and 2 months
B. Net Present Value Method (NPV)

It is the classic economic method of evaluating the investment proposals. It is discounted cash
flow technique that explicitly recognizes the time value of money. It correctly postulates that
cash flows arising at different time periods differ in value and comparable only when this
equivalents- present value- are found out.

Steps to calculate the net present value of an investment proposal

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 1. Cash flows of the investment project should be forecasted based on realistic
assumption.
2. Appropriate discount rate should be identified to discount the forecasted cash
flows. The discount rate is the project opportunity cost of capital, which is
equal to the required rate of return expected by investors on the investment
of equivalent risk.
3. Present values of cash flow should be calculated.
4. Net present values should be found out by subtracting present value of cash
outflows from present value of cash inflows.

Formula used to calculate the Net Present Value of any project proposal
n
Ci
NPV =   C0
i 1 (1  k )t

Where: NPV = Net Present Value

Ci = Periodic Cash Inflow
C0 = Cash Outflow/ Initial Investment
Acceptance rule
 Accept the project when NPV is positive; NPV>0
 Reject the project when NPV is negative; NPV<0
 May accept the project when NPV is zero; NPV=0

Note:
The NPV method can be used to select between mutually exclusive projects; the one with the
higher NPV should be selected.
Merits of NPV
It provides the most acceptable investment rule for the following reasons:
a. Time Value: It recognizes the time value of money- a birr received today is worth
more than a birr received tomorrow.
b. Measure of true profitability: It uses all cash inflows and outflows occurring
over the entire life of the project in calculating its worth (value). Hence, it is a
measure of the projects true profitability.
c. Value Additivity: The discounting process facilitates measuring cash flows in
terms of present value. Therefore, the NPVs of projects can be added. That is;
NPV (A+B) =NPV (A) +NPV (B). It implies that if we know the NPVS of
individual projects, the value of the firm will increase by the sum of their NPVS.

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 d. Shareholders Value: The NPV method is always consistent with the objective of
the shareholder value maximization.

Demerits of NPV
a. Cash flow Estimation: The NPV method is easy to use if forecasted cash
flows are known. In practice, it is quite difficult to obtain the estimates of
cash flow due to uncertainty
b. Discount rate: If is difficult in practice to precisely measure the discount
rate.
c. Mutually exclusive projects: caution needs to be applied in using NPV
method when alternative (Mutually exclusive) projects with unequal lives or
under funded constraints are evaluated.
d. Ranking of projects: ranking of investment projects as per the NPV rate is
not independent of the discount rate.

Example: suppose project ‘A’&’B’ - both costing Br 50 each. Project ‘A’ returns Br 100 after
one year & Br 25 after two years. On the other hand, project ‘B’ returns Br 30 after one years
and Br 100 after two years. At discount rates of 5% &10% NPV of ‘A’ & ’B’ are as follows:

Project NPV at 5% Rank NPV at 10% Rank

A 67.92 II 61.57 I
B 69. 27 I 59.91 II

As you can see from the solution, the project raking is reversed when discount rate is changed
from 5% to 10% .The reason lies in the cash flow patterns.
Example: Assume that a machine will cost Br 100,000 and will provide annual net cash in flows
of Br 50,000; Br 40,000; Br 30,000; Br 20,000; Br 20,000; and Br 20,000 for six years. The cost
of capital is 15%. Calculate the Machines net present value. Should the Machine be purchased?

Solution

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Year cash in flow Discounted factor Discounted cash flow
0 -100,000 1.000 -100,000
1 50,000 0.8696 43,480
2 40,000 0.7561 30,244
3 30,000 0.6575 19,725
4 20,000 0.5718 11,436
5. 20,000 0.4972 9,944
6 20,000 0.4323 8,646
Net Present Value……Br. 23,475
Total present value = Birr 123,475
The Net Present Value (NPV) = PV of cash inflows - PV of cash out flow
= Birr 123,457- Birr100, 000
= Birr 23,475
Decision:
Since the NPV of the Machine is positive, the machine should be purchased.
C) Internal Rate of Return (IRR)
Other terms used to describe the IRR method are yield on an investment, marginal efficiency of
capital, rate of return over cost, time adjusted rate of internal return etc,. Thus, internal rate of
return is defined as the rate that equates the investment outlay with the present value of cash
inflow received after one period. This implies that the rate of return is the discounts rate which
makes NPV =0
n
Ct
At the exact IRR;  1  r - C0 = 0
i 1

Where: IRR=Internal Rate of Return

Ct = Periodic cash inflows
r = the internal rate of return
C0 = Cash outflows/ Initial Investments
Merits of IRR
1. Time value: It recognizes time value of money.
2. Profitability Measures; It considers all cash flows occurring over the entire life of the
project to calculate its IRR.

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 3. Acceptance rule: It gives the same acceptance rule as the NPV method.
4. Shareholders value: It is consistent with the shareholders wealth maximization
objectives. Whenever a project IRR is greater than the opportunity cost of capital the
shareholders wealth will be enhanced.
Demerits of IRR
1. Multiple rates: A project may have multiple rates or it may not have a unique rate of
return.
2. Mutually exclusive projects: It may fail to indicate a correct choice between mutual
exclusive projects under certain conditions.
3. Value additivity: Unlike in the case of the NPV method, the value aditivity principle
does not hold when the IRR method is used. Internal rate of return of projects do not add.
That is, for projects ‘A’&’B’ ; IRR (A) +IRR (B) need not be equal to IRR (A+B) . This
value additivity can be identified from the following example.
Example: NPV and IRR of projects ‘A’&’B’ are given below:
Projects C0 Ci NPV at 10% IRR

A -100 120 +9.1 20

B -150 168 +2.7 12
A+B -250 288 11.8 15.2

 NPV (A) + NPV (B) = NPV (A+B); 9.1+2.7= 11.8

IRR (A) + IRR (B) # IRR (A+B); 20%+12%# 15.2%
Acceptance Rule:
 Accept the project when internal rate of return is greater than the opportunity cost of
capital; r>k
 Reject the project when internal rate of return is less than the opportunity cost of
capital; r<k
 May accept the when internal rate of return is equals to the opportunity cost of
capital; r=k
Example: Assume that a machine will cost Br 100,000 and will provide annual net cash inflows
for the coming six years are as follows:

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Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
50,000 40,000 30,000 20,000 20, 000 20,000
The cost of capital is 15%. Calculate the machines IRR. Should the machine be purchased?
There is no a ready made formula to compute the internal rate of return of an investment
proposal just like other investment evaluation criteria. It can be calculated through trial and error.

Assume r=26% Assume r= 25%

PV at 26%
50,000x0.794 = 39,700
40,000x0.630 = 25,200
30.000x0.500 = 15,000
20,000x0.397 = 7,940
20,000x0.315 = 6,300
20,000x0.250 = 5,000
PV of inflows 99,140
PV at 25%
50,000x0.800 = 40,000
40,000x0.640 = 25,600
30,000x0.512 = 15,360
20,000x0.410 = 8,192
20,000x0.328 = 6,553.60
20,000x 0.262 = 5,242.88
100,948

Solution
Now you have to use the interpolation method to find out the exact internal rate of return.
Interpolation Method
X
Required IRR= LR + (HR - LR)
Y
Where:
LR= Lower assumed IRR
HR= Higher assumed IRR
X= The difference between the PV of cash inflow at lower assumed IRR
and PV of cash inflow at the required/exact IRR.
Y= The difference between the PV of cash inflow at lower assumed IRR
and PV of cash inflow at the higher assumed IRR.
860
Required IRR = 25% + (26% - 25%)
1808
Required IRR = 25% + 0.48%
Required IRR = 25.48%
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Decision:
Since the required internal rate of return of the machine (25.48%) is greater than the cost of
capital (15%), the machine should be purchased.

D) Profitability index
It is the ratio of the present value of cash inflows at the required rate of return, to the initial cash
out flows of the investment.
n
Ci
 (1  i)n
i 1
PI =
C0
Where: PI = Profitability Index
Ci = Periodic cash inflow
C0 = Cash outflows/Initial cash outlays
i = Required rate of return
n = Number of periods
Acceptance Rule:
 Accept the project when profitability index is grater than one; PI>1
 Reject the project when profitability index is less than one; PI<1
 May accept/reject the project when profitability index is one; PI=1
Merits
1. Time value: it recognizes the time value of money.
2. Value Maximization: it is consistent with the shareholders value maximization
principle. If a project PI is greats than one, it will increase the shareholders value.
3. Relative profitability: since the present value of cash inflows is divided by the initial
cash out flow, it a relative measure of a project’s profitability
Demerits
1. Estimation of cash flows.
2. Estimation of discount rate.
Example: Assume that a machine will cost Br 100,000 and will provide annual net cash inflows
for the coming six years are as follows:
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 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

50,000 40,000 30,000 20,000 20, 000 20,000

The cost of capital is 15%.
Calculate the machines PI. Should the machine be purchased?
Solutions

Year cash inflows Discount factor of 15% Discounted cash inflow

1 50,000 0.8696 43,480

2 40,000 0.7561 30,244
3 30,000 0.6575 19,725
4 20,000 0.5718 11,436
5 20,000 0.4972 9,944
6 20,000 0.4323 8,646

PV of cash inflows = 123,475

n
Ci
 (1  i)n
i 1 Br123,475
PI = = = 1.235
C0 Br100,000
Decision
Since, the projects PI is greater than one (i.e. 1.235), the machine should be purchased.

2. NON-DISCOUNTED CASH FLOW TECHNIQUES

A) Pay Back Period (PBP)

Pay Back Period method is a traditional method of evaluation of capital budgeting decision. The
term pay back period refers to the period in which the project will generate the necessary cash to
recover the original investment of the project. In other words, it is the number of year required to
recover the original cash outlay invested in a project.

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Acceptance rule
There is no any common standard which is used by all firms commonly. It is depending upon the
decision of a firm. Generally, they compare the project pay back with predetermined standard
pay back. The project would be accepted if its pay back period is less than the maximum or
standard pay back period set by management. During raking, the first rank will be given for a
project having the shortest pay back period.

Merits of PBP
1. Simplicity: it is simple to understand and easy to calculate.
2. Cost-effective: Pay Back Period method cost less than most of the sophisticated
techniques that requires a lot of the analyst time and the use of computer.
3. Short-Term Effects: A company can have more favorable short run effect on earning per
share by setting up a shorter standard Pay Back Period.
4. Risk shield: The risk of the project can be tackled by having a shorter standard pay back
period as it may ensure guarantee against loss. A company has to invest in many projects
where the cash inflows are highly uncertain. Under such conditions pay back may
become important, not as a measure of profitability but as a means of establishing an
upper bound on the acceptable degree of risk
5. Liquidity: The emphasis in PBP is on the early recovery of the investment. Thus
it gives an insight in to the liquidity of the project.

Demerits
1) Cash flows After Payback: Pay Back Period fails to take account of the cash
inflows earned after the PBP.
2) Cash flows ignored: Pay Back Period is not an appropriate method of measuring
the profitability of an investment project as it does not consider all cash inflows
yielded by the project.
3) Cash flows pattern: Pay Back Period fails to consider the pattern of cash
inflows; i.e., magnitude and timing of cash inflows.

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Example:
Cash Flows

Project Year 0 Year 1 Year 2 Year 3 PBP NPV@10%

A -5,000 3,000 2,000 2,000 2years +881
B -5,000 2,000 3,000 2,000 2years +798
As you can see from the solution both projects ‘A’ & ‘B’ have equal pay back period, but
different NPV. It happens because of the failure to consider all the cash inflows as well as the
time value of money.
4) Administrative difficulties: Firms may face difficulties in determining the
maximum acceptable PBP. There is no rational basis for setting a maximum PBP.
It is subjective.
5) Inconsistent with shareholder value: PBP is not consistent with the objective of
maximizing the market value of the firm’s share.
PBP (for constant cash flows)
If the project generates constant annual cash inflows, the PBP can be computed by dividing total
cash outlay by the annual cash inflow.

PBP = Initial Cash Outlay

Annual Cash Inflow

Example: Assume that a project requires an outlay of Birr 50,000and yields annual cash inflow
of Birr 12,500 for seven years. What would be the pay back period of the project?

PBP = Initial Cash Outlay

Annual Cash Inflow

Br 50,000
PBP = = 4 Years
Br12,500
The company can recover the initial cash outlay within four years.

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PBP (For uneven cash flows)

Example: Assume that a project requires a cash outlay of Br. 20,000 and generates cash inflows
of Br 8,000; Br 7,000; Br, 4,000 and Br 3,000 during the next 4 years. What would be the pay
back period of the project?

Solutions
When we add up the cash inflows of the first three years, we will get Br.19, 000. Br 1000
remained to cover the original out lay. This Birr 1000 will be covered in year 4.

In year 4, Br 3,000 generated. Thus, 4 months are required to generate Br 1,000.

Hence, PBP = 3years and 4 months.
In other way
Year Cash flow Cumulative CF
1 8,000 8,000
2 7,000 15,000
3 4,000 19,000
4 3,000 22,000*

Payback period = Year before full recovery + unrecovered cost /

Annual cash inflow during the next year
Discounted Pay back period = 3 years + (1,000/3,000) years
= 3 years + 0.3333 years = 3.3333 years
Or
= 3 years + (0.3333) (12 months)
= 3 years and 4 months

B) Accounting Rate of Return (ARR)

It also known as return on investment (ROI) uses accounting information, as revealed by
financial statements to measure the profitability of investment. ARR is the ratio of the average
profit after tax divided by the average investment. The average investment would be equal to half
of the original investment if it were depreciated constantly. Alternatively, it can be found out by
dividing the total of the investments book values after depreciation by the life of the project.
ARR= Average Income

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 Average Investment
n

 EBITt (1  T ) n
i 1
ARR =
( Io  In)
2

Where:
EBITt = Earning before Tax and Interest for ‘t’ time periods.
T = Income Tax Rate.
n = Number of periods.
Io = Beginning Balance of Investment
In = Ending Balance of Investment.
Acceptance Rule- As an acceptance or reject criterion, this method will accept all those projects
whose ARR is higher than the minimum rate established by the management and reject those
projects which have ARR less than the minimum rate.
Merits:
1. Simplicity
2. Accounting data.
3. Accounting profitability.

Demerits
1. Cash flows ignored
2. Time value ignored
3. Arbitrary cut off

Example:
A project will cost Br 40,000. Its stream of earnings before depreciation, interest and taxes
(EBDIT) during first year through five years is expected to be Br.10,000; 12,000 ; 14,000;
16,000 and 20,000 respectively. Assume a 50% tax rate and depreciation on straight line.
Salvage value is zero. What would be the Accounting Rate of Return?

Solutions

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 AV  SV
Depreciation =
UL

Where: AV: Asset Value

SV: Salvage Value
UL: Useful Life of an asset
40,000  0
Depreciation = = Birr 8,000 per year.
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Years Cash inflows Depreciation EBIT Tax(50%) EAT

1 10,000 8,000 2,000 1,000 1,000

2 12,000 8,000 4,000 2,000 2,000
3 14,000 8,000 6,000 3,000 3,000
4 16,000 8,000 8,000 4,000 4,000
5 20,000 8,000 12,000 6,000 6,000
16,000

 EBITt (1  T ) n
i 1
ARR =
( Io  In)
2
Br16,000
5 years
ARR = 100% = 16%
Br 40,000
2
Alternative Method
Periods

Year 1 Year 2 Year 3 Year 4 Year 5 Average

EBDIT 10,000 12,000 14,000 16,000 20,000 14, 400

Depreciation 8,000 8,000 8,000 8,000 8,000 8,000

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EBIT 2,000 4,000 6,000 8,000 12,000 6,400
Tax (50%) 1,000 2,000 3,000 4,000 6,000 3,200
EBIT (1-T) 1,000 2,000 3,000 4,000 6,000 3,200

BV. Investment:
Beginning 40,000 32,000 24,000 16,000 8,000 24,000
Ending 32,000 24,000 16,000 8,000 0 16,000
Average 36,000 28,000 20,000 12,000 4,000 20,000
The Accounting Rate of Return of a project is:
ARR= Average Income
Average Investment
Birr 3,200
ARR =  100%
Birr 20,000
ARR = 16%

Thus, to make a decision a company has to compare the computed ARR with its predetermined
ARR. If the computed value is greater than the predetermined, the project will be accepted. But if
the reverse happens, the project will be rejected.

Summary
 Capital budgeting decisions relate to long term assets which are in operation and yield a
return over a period of time. Therefore, they involve current outlays in return for series of
anticipated flow of future benefit.
 The investment in capital projects can be categorized in to (1) Dependent projects, (2)
Independent projects and (3) Mutually exclusive projects.
 The data requirement for capital budgeting are after tax cash outflows and cash inflows.
Thus, the profitability of an investment project is determined by evaluating its cash
inflows.
 The investment evaluation techniques are classified as discounted cash flow technique
and non-discounted cash flow technique.

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  The discounted cash flow techniques are (1) Net present value, (2) Internal rate of return,
and (3) Profitability Index
 .Net Present Value method is a process of calculating the present value of the project’s
cash flows, using the given cost of capital as a discount rate, and finding out the net
present value by subtracting the initial investment from the present value of cash inflows.
 The internal rate of return is the discount rate at which the project’s net present value is
zero. That means the rate that equates the present value of cash inflow with the initial
cash outlay.
 Profitability Index is the ratio of the present value of cash inflows to initial cash outlay.
 The non-discounted cash flow technique includes (1) Pay Back Period, and (2)
Accounting Rate of Return.
 Pay Back Period is the number of years required to recover the initial cash outlay of an
investment project.
 Accounting Rate of Return is found out by dividing the average net operating profit after
tax by the average amount of investment.

SELF ASSESSMENT QUESTIONS

Part I. Say true or false

1. The internal rate of return and net present value are the same.
2. Cash flows from a project can be estimated accurately.
3. IRR determines the maximum rate of interest that a firm can afford to pay on the
borrowings for a particular project.
4. PBP takes in to account the cash flows after the pay back period.
5. Discounted cash flow techniques takes into account the time value of money.
Part II. Choose the correct answer
1. While evaluating capital investment proposals, the time value of money is considered in
the case of
a. Pay Back Period
b. Internal Rate of Return
c. Accounting Rate of Return
2. The return after the pay-off period is not considered in case of

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 a. Pay- Back Period
b. Internal Rate of Return
c. Profitability Index
3. Depreciation is included in costs in case of
a. Pay Back Period
b. Accounting Rate of Return
c. Profitability Index

Part III. Solve the following problems

1. A project costs Birr 2,000,000 and yields annually a profit of Birr 300,000 after
depreciation at 12.5% but before tax at 50%. Calculate the pay back period.
2. Dashen trading company is considering two projects. Each requires an investment of
Birr 20,000. The net cash flows from investment in the two projects X and y are as
follows:

Year Project X Project Y

1 10,000 4,000
2 8,000 5,000
3 6,000 6,000
4 4,000 7,000
5 2,000 8,000
6 1,000 10,000

The required rate of return is 10 per cent.

Instruction:
Compute
a) Net Present Value of each project and give decision.
b) Internal Rate of Return of each project give decision
c) Profitability Index of each project give decision
d) Pay Back Period of each project give decision

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