Capital Budgeting

Techniques

13-1
 Project Evaluation:
Alternative Methods

 Payback Period (PBP)

 Internal Rate of Return (IRR)
 Net Present Value (NPV)
 Profitability Index (PI)

13-2
 Proposed Project Data

Julie Miller is evaluating a new project

for her firm Basket Wonders (BW).
She has determined that the after-tax
cash flows for the project will be
$10,000, $12,000, $15,000, $10,000,
and $7,000 respectively for each of
the Years 1 through 5. The initial
cash outlay will be $40,000.
13-3
 Independent Project
For this project, assume that it is
independent of any other potential
projects that Basket Wonders may
undertake.
Independent -- A project whose
acceptance (or rejection) does not
prevent the acceptance of other
projects under consideration.
13-4
 Payback Period (PBP)

0 1 2 3 4 5

-40 K 10 K 12 K 15 K 10 K 7K

PBP is the period of time

required for the cumulative
expected cash flows from an
investment project to equal
the initial cash outflow.
13-5
 Payback Solution (#1)

0 1 2 3 (a) 4 5

-40 K (-b) 10 K 12 K 15 K 10 K(d) 7K

10 K 22 K 37 K(c) 47 K 54 K

Cumulative
Inflows PBP =a+(b-c)/d
= 3 + (40 - 37) / 10
= 3 + (3) / 10
= 3.3 Years
13-6
 Payback Solution (#2)

0 1 2 3 4 5

-40 K 10 K 12 K 15 K 10 K 7K
-40 K -30 K -18 K -3 K 7K 14 K

PBP = 3 + ( 3K ) / 10K
Cumulative = 3.3 Years
Cash Flows
Note: Take absolute value of last
negative cumulative cash flow
13-7 value.
 PBP Acceptance Criterion
The management of Basket Wonders
has set a maximum PBP of 3.5
Years for projects of this type.
Should this project be accepted?

Yes! The firm will receive back the

initial cash outlay in less than 3.5
Years. [3.3 Years < 3.5 Year Max.]

13-8
 PBP Strengths and Weaknesses

Strengths: Weaknesses:
Tidak
 Mudah digunakan
dan dimengerti menghitung TVM
 Dapat digunakan  Mengabaikan cash
untuk mengukur flow setelah Pay
likuiditas
Back Period
 Lebih mudah untuk
perkiraan arus kas jangka
pendek dari pada jangka
panjang.
13-9
 Internal Rate of Return (IRR)

IRR merupakan discount rate yang

menyamakan present value dari net
cash flows masa yang akan datang dari
investasi dengan initial cash outflow.

CF1 CF2 CFn

ICO = + +...+
(1+IRR)1 (1+IRR)2 (1+IRR)n

13-10
 IRR Solution

$40,000 = $10,000 $12,000

+ +
(1+IRR)1 (1+IRR)2
$15,000 $10,000 $7,000
+ +
(1+IRR)3 (1+IRR)4 (1+IRR)5

Temukan interest rate (IRR) yang menyebabkan

discounted cash flows sama dengan $40,000.

13-11
 IRR Solution (Try 10%)

$40,000 = $10,000(PVIF10%,1) + $12,000(PVIF10%,2) +

$15,000(PVIF10%,3) + $10,000(PVIF10%,4) +
$ 7,000(PVIF10%,5)
$40,000 = $10,000(.909) + $12,000(.826) +
$15,000(.751) + $10,000(.683) +
$ 7,000(.621)
$40,000 = $9,090 + $9,912 + $11,265 +
$6,830 + $4,347
= $41,444 [Discount Rate terlalu rendah!]
13-12
 IRR Solution (Try 15%)

$40,000 = $10,000(PVIF15%,1) + $12,000(PVIF15%,2) +

$15,000(PVIF15%,3) + $10,000(PVIF15%,4) +
$ 7,000(PVIF15%,5)
$40,000 = $10,000(.870) + $12,000(.756) +
$15,000(.658) + $10,000(.572) +
$ 7,000(.497)
$40,000 = $8,700 + $9,072 + $9,870 +
$5,720 + $3,479
= $36,841 [Discount Rate is too high!!]
13-13
 IRR Solution (Interpolate)

.10 $41,444
X $1,444
.05 IRR $40,000 $4,603
.15 $36,841

X $1,444
.05 = $4,603

13-14
 IRR Solution (Interpolate)

.10 $41,444
X $1,444
.05 IRR $40,000 $4,603
.15 $36,841

X $1,444
.05 = $4,603

13-15
 IRR Solution (Interpolate)

.10 $41,444
X $1,444
.05 IRR $40,000 $4,603
.15 $36,841

X = ($1,444)(0.05) X = .0157
$4,603
IRR = .10 + .0157 = .1157 or 11.57%
13-16
 IRR Acceptance Criterion

Jika Biaya modal Basket Wonders

13% dan IRR rencana investasi
11,57%

Maka rencana Investasi ditolak

13-17
 IRR Strengths
and Weaknesses
Weaknesses:
Strengths:
a. Mengasumsikan
a. Memperhitung semua cash flows
kan TVM direinvestasi pada
tingkat bunga sebesar
b. Mempertimba IRR
ngkan semua b. Muncul kesulitan jika
cash flows terdapat arus kas tidak
normal (mis negatif),
c. Mengurangi yang akan
subyektivitas menimbulkan Multiple
IRR
13-18
 Net Present Value (NPV)

NPV adalah present value dari

net cash flow investasi dikurangi
initial cash outflow proyek
invetasi.

CF1 CF2 CFn

NPV = + +...+ - ICO
(1+k)1 (1+k)2 (1+k) n

13-19
 NPV Solution
Basket Wonders telah menentukan
discount rate (k) projek investasi 13%.

NPV = $10,000 +$12,000 +$15,000 +

(1.13)1 (1.13)2 (1.13)3
$10,000 $7,000
4 + 5 - $40,000
(1.13) (1.13)

13-20
 NPV Solution
NPV = $10,000(PVIF13%,1) + $12,000(PVIF13%,2) +
$15,000(PVIF13%,3) + $10,000(PVIF13%,4) +
$ 7,000(PVIF13%,5) - $40,000
NPV = $10,000(.885) + $12,000(.783) +
$15,000(.693) + $10,000(.613) +
$ 7,000(.543) - $40,000
NPV = $8,850 + $9,396 + $10,395 +
$6,130 + $3,801 - $40,000
= - $1,428
13-21
 NPV Acceptance Criterion
Jika manajemen Basket Wonders
menentukan required rate 13% untuk
projek investasi tersebut.
Apakah investasi akan diterima?

Tidak! Karena NPV is negative. Yang berarti

bahwa proje investasi akan mengurangi
kekayaan pemegang saham. [Reject as NPV <
0]

13-22
 NPV Strengths
and Weaknesses

Strengths:
1. Cash flows diasumsikan diinvestasikan
pada tingkat keuntungan yang
disyaratkan.
2. Menggunakan TVM.
3. Memperhitungkan semua cash flows.

13-23
 Net Present Value Profile
$000s
Sum of CF’s Plot NPV for each
15 discount rate.
Net Present Value

10

5 IRR
NPV@13%
0
-4
0 3 6 9 12 15
Discount Rate (%)
13-24
 Profitability Index (PI)

PI adalah rasio present value dari net

cash flows masa mendatang dengan
initial cash outflow proyek.
CF1 CF2 CFn
PI = + +...+ ICO
(1+k)1 (1+k) 2 (1+k)n

13-25
 PI Acceptance Criterion
PI = $38,572 / $40,000
= .9643

Should this project be accepted?

No! The PI is less than 1.00. This

means that the project is not profitable.
[Reject as PI < 1.00 ]
13-26
 Evaluation Summary

Basket Wonders Independent Project

Method Project Comparison Decision

PBP 3.3 3.5 Accept
IRR 11.57% 13% Reject
NPV -$1,428 $0 Reject
PI .96 1.00 Reject
13-27
 Other Project
Relationships
 Dependent –Penerimaan suatu proyek
tergantung pada penerimaan proyek
lainnya. Misal penerimaan mesin baru
berukuran besar yang memerlukan
tambahan ruangan.

MutuallyExclusive –
Penerimaan suatu proyek
akan menghalangi
penerimaan proyek lainnya
13-28
 Capital Rationing
Capital Rationing terjadi jika jika terdapat
keterbatasan dana (budget ceiling).

Example
Jika Julie Miller dari Basket Wonders
menentukan beberapa investasi yang akan
dipilih, dengan dana yang dimiliki (maximum
expenditure) $32,500 pada 199X.
13-29
 Available Projects for BW
Project ICO IRR NPV PI
A $ 500 18% $ 50 1.10
B 5,000 25 6,500 2.30
C 5,000 37 5,500 2.10
D 7,500 20 5,000 1.67
E 12,500 26 500 1.04
F 15,000 28 21,000 2.40
G 17,500 19 7,500 1.43
H 25,000 15 6,000 1.24
13-30
 Pemilihan berdasarkan IRR

Project ICO IRR NPV PI

C $ 5,000 37% $ 5,500 2.10
F 15,000 28 21,000 2.40
E 12,500 26 500 1.04
B 5,000 25 6,500 2.30
Projects C, F, dan E mempunyai IRR
tertinggi.
Yang menyebabkan peningkatan pada
kekayaan shareholder pemegang saham
13-31
$27,000 dengan outlay $32,500.
 Pemilihan berdasarkan NPV

Project ICO IRR NPV PI

F $15,000 28% $21,000 2.40
G 17,500 19 7,500 1.43
B 5,000 25 6,500 2.30
Projects F and G have the
two largest NPVs.
The resulting increase in shareholder
wealth is $28,500 with a $32,500 outlay.
13-32
 Pemilihan Berdasarkan PI
Project ICO IRR NPV PI
F $15,000 28% $21,000 2.40
B 5,000 25 6,500 2.30
C 5,000 37 5,500 2.10
D 7,500 20 5,000 1.67
G 17,500 19 7,500 1.43
Projects F, B, C and D have the four largest PIs.
The resulting increase in shareholder wealth is
$38,000 with a $32,500 outlay.
13-33