Capital budgeting or investment appraisal, is the plann

Capital to determine whether an organization's long term inve

new machinery, replacement of machinery, new plant
Budgeting: and research development projects are worth the fund
through the firm's capitalization structure.

1- PayBack Period: The payback period refers to the amount of time it tak
an investment. Simply put, the payback period is the length of time an inv
breakeven point.
2- Net Present Value: is the difference between the present value of cash
value of cash outflows over a period of time. NPV is used in capital budge
Method of planning to analyze the profitability of a projected investment or project.
Capital 3- Internal Rate of Return (IRR): is a core component of capital budgeting
Businesses use it to determine which discount rate makes the present val
Budgiting: cash flows equal to the initial cost of the capital investment.

4- Modified Internal Rate of Return (MIRR): assumes that positive cash flo
firm's cost of capital and that the initial outlays are financed at the firm's
contrast, the traditional internal rate of return (IRR) assumes the cash flow
reinvested at the IRR itself.

Disposable Income: = Personal Income - Taxes

Income remaining after deduction of taxes and social security
avilable to spent or save as one wishes.

Discretionary Income: = Disposable Income - Financ

Income remaining after deduction of taxes and social security
basic living cost.
praisal, is the planning process used
on's long term investments such as
chinery, new plants, new products,
are worth the funding of cash
cture.

he amount of time it takes to recover the cost of

the length of time an investment reaches a

he present value of cash inflows and the present

V is used in capital budgeting and investment
d investment or project.
nent of capital budgeting and corporate finance.
te makes the present value of future after-tax
nvestment.

mes that positive cash flows are reinvested at the

re financed at the firm's financing cost. By
RR) assumes the cash flows from a project are

me - Taxes
d social security charges,

ncome - Financial Obligations

d social security charges, and
Example:

Salary $ 20,000.00 increase in Salary

Expenses $ 16,000.00 increase in Expenses

Avg. Propensity to Consume = 0.8

Avg. Propensity to Save = 20%

Marginal Propensity = 75%

$ 2,000.00
$ 22,000.00
$ 17,500.00
$ 1,500.00

80%

100%

Consume
Example: Initial Investment = $ 100,000.00

Year Project "A" Year Project "B"

1 $ 48,000.00 1 $ 60,000.00
2 $ 52,000.00 2 $ 36,000.00
3 $ 60,000.00 3 $ 48,000.00

1- PayBack Period:

Project "A" Project "B"

1 $ 48,000.00 1 $ 60,000.00
2 $ 100,000.00 2 $ 96,000.00
1 month $ 100,000.00

Payback Period = 2 Years Payback Period =

Choose Project "A" as it is the fastest to recover the initial investment

2- Net Present Value:

WAAC = 10%
1 Period & 10% 0.909 x $ 48,000.00
Project 2 Period & 10% 0.826 x $ 52,000.00
A 3 Period & 10% 0.751 x $ 60,000.00
Present Value =
Initial Investment =
Net Present Value =

3- Internal Rate of Return (IRR):

Step #1 Make sure that NPV (31,690.46) would be equal to zero.

Step #2 This mean that Present Value (131,690.46) should be equal to the initial investment ($10,000)
Step #3 This mean that we have to reduce each discounted annual cash flow.
Step #4 For A we can do this by reduce annual cash flow, this option is not feasible because these are given

1 Period & 26.5% 0.791 x $ 48,000.00

Project 2 Period & 26.5% 0.625 x $ 52,000.00
A 3 Period & 26.5% 0.494 x $ 60,000.00
Present Value =
IRR = 26.50% Initial Investment =
 Net Present Value =

4- Modified Internal Rate of Return (MIRR):

Y1 = 48,000 Y2 = 52,000 Y3 = 60,000

1 Periods & 10% = 1.1 x 52,000

2 Period & 10% = 1.21 x 48,000

?%
$100,000

2 Period & 10% 1.210 x $ 48,000.00

Project 1 Period & 10% 1.100 x $ 52,000.00
A 0 Period & 10% 1.000 x $ 60,000.00
Terminal Value =
Initial Investment =
P.V Factor =
MIRR =

3 Periods

CashFlow $ (100,000.00) $ 48,000.00 $ 52,000.00

Year 0 1 2

MIRR = 21%
 / 12 months = $ 4,000.00

2 Years and 1 Month

Now (Time 0)
= $ 43,636.36 1 Period & 10% 0.909
= $ 42,975.21 Project 2 Period & 10% 0.826
= $ 45,078.89 B 3 Period & 10% 0.751
Present Value = $ 131,690.46
Initial Investment = $ 100,000.00
Net Present Value = $ 31,690.46

Choose Project "A" as it has the Highest Net Present Value

initial investment ($10,000)

t feasible because these are given fact. For B reduce Present value factor, this is the only feasible option. We can do that using Trail an

= $ 37,944.66 1 Period & 21.5% 0.823

= $ 32,495.43 Project 2 Period & 21.5% 0.677
= $ 29,640.10 B 3 Period & 21.5% 0.558
Present Value = $ 100,080.19
Initial Investment = $ 100,000.00 IRR = 21.50%
Net Present Value = $ 80.19
Choose Project "A" as it has the Highest IRR

Y1 = 60,000 Y2 = 36,000

1 Periods & 10% = 1.1 x 36,0

Terminal
Value 2 Period & 10% = 1.21 x 60,000

$100,000 ?%

= $ 58,080.00 2 Period & 10% 1.210

= $ 57,200.00 Project 1 Period & 10% 1.100
= $ 60,000.00 B 0 Period & 10% 1.000
Terminal Value = $ 175,280.00
Initial Investment = $ 100,000.00
P.V Factor = 0.571
MIRR = 20%

0.571

$ 60,000.00 CashFlow $ (100,000.00)

3 Year 0

MIRR = 17%

Choose Project "A" as it has the Highest MIRR

 Now (Time 0)
x $ 60,000.00 = $ 54,545.45
x $ 36,000.00 = $ 29,752.07
x $ 48,000.00 = $ 36,063.11
Present Value = $ 120,360.63
Initial Investment = $ 100,000.00
Net Present Value = $ 20,360.63

ption. We can do that using Trail and Error method.

x $ 60,000.00 = $ 49,382.72
x $ 36,000.00 = $ 24,386.53
x $ 48,000.00 = $ 26,761.62
Present Value = $ 100,530.86
Initial Investment = $ 100,000.00
 Net Present Value = $ 530.86

= 36,000 Y3 = 48,000

1 Periods & 10% = 1.1 x 36,000

Terminal
= 1.21 x 60,000 Value

?%

x $ 60,000.00 = $ 72,600.00
x $ 36,000.00 = $ 39,600.00
x $ 48,000.00 = $ 48,000.00
Terminal Value = $ 160,200.00
Initial Investment = $ 100,000.00
P.V Factor = 0.624
MIRR = 17%

3 Periods 0.624

$ 60,000.00 $ 36,000.00 $ 48,000.00

1 2 3