Capital Budgeting Techniques Capital Budgeting Techniques

Chapter 13
Capital
Capital Budgeting
Budgeting
Techniques
Techniques
13.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
After Studying Chapter 13,
you should be able to:
1. Understand the payback period (PBP) method of project evaluation and
selection, including its: (a) calculation; (b) acceptance criterion; (c)
advantages and disadvantages; and (d) focus on liquidity rather than
profitability.
2. Understand the three major discounted cash flow (DCF) methods of
project evaluation and selection – internal rate of return (IRR), net
present value (NPV), and profitability index (PI).
3. Explain the calculation, acceptance criterion, and advantages (over the
PBP method) for each of the three major DCF methods.
4. Define, construct, and interpret a graph called an “NPV profile.”
5. Understand why ranking project proposals on the basis of IRR, NPV, and
PI methods “may” lead to conflicts in rankings.
6. Describe the situations where ranking projects may be necessary and
justify when to use either IRR, NPV, or PI rankings.
7. Understand how “sensitivity analysis” allows us to challenge the single-
point input estimates used in traditional capital budgeting analysis.
8. Explain the role and process of project monitoring, including “progress
reviews” and “post-completion audits.”
Capital
Capital Budgeting
Budgeting
Techniques
Techniques
• Project Evaluation and Selection
• Potential Difficulties
• Capital Rationing
• Project Monitoring
• Post-Completion Audit
Project
Project Evaluation:
Evaluation:
Alternative
Alternative Methods
Methods
• Payback Period (PBP)
• Internal Rate of Return (IRR)
• Net Present Value (NPV)
• Profitability Index (PI)
• Refer to the additional PowerPoint slides and the Excel
spreadsheet “VW13E-13b.xlsx” for computer-based
solutions.
Proposed
Proposed Project
Project Data
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.
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.
Payback
Payback Period
Period (PBP)
(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.
Payback
Payback Solution
Solution (#1)
(#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
Payback
Payback Solution
Solution (#2)
(#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 = 3.3

Cumulative Years
Cash Flows Note: Take absolute value of last
negative cumulative cash flow value.
PBP
PBP Acceptance
Acceptance Criterion
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.]
PBP
PBP Strengths
Strengths
and
and Weaknesses
Weaknesses
Strengths: Weaknesses:
• Easy to use and • Does not account
understand for TVM
• Can be used as a • Does not consider
measure of cash flows beyond
liquidity the PBP
• Easier to forecast • Cutoff period is
ST than LT flows subjective
Internal
Internal Rate
Rate of
of Return
Return (IRR)
(IRR)
IRR is the discount rate that equates the

present value of the future net cash
flows from an investment project with
the project’s initial cash outflow.
CF1 CF2 CFn

ICO = (1 + IRR)1 + (1 + IRR)2 + . . . + (1 + IRR)n
IRR
IRR Solution
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
Find the interest rate (IRR) that causes the

discounted cash flows to equal $40,000.
IRR
IRR Solution
Solution (Try
(Try 10%)
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(0.909) + $12,000(0.826) +
$15,000(0.751) + $10,000(0.683) +
$ 7,000(0.621)
$40,000 = $9,090 + $9,912 + $11,265 +
$6,830 + $4,347
= $41,444 [Rate is too low!!]
IRR
IRR Solution
Solution (Try
(Try 15%)
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(0.870) + $12,000(0.756) +
$15,000(0.658) + $10,000(0.572) +
$ 7,000(0.497)
$40,000 = $8,700 + $9,072 + $9,870 +
$5,720 + $3,479
= $36,841 [Rate is too high!!]
IRR
IRR Solution
Solution (Interpolate)
(Interpolate)
0.10 $41,444
X $1,444
0.05 IRR $40,000 $4,603
(0.15-0.10) 0.15 $36,841
X $1,444
0.05 = $4,603
10% 41430
0.05 X IRR 40,000 1430 4590
15% 36,841
X/0.05 =1430/4590
X=1430/4590*0.05=0.0155
IRR
IRR Solution
(Interpolate)
0.10 $41,444
X $1,444
0.05 IRR $40,000 $4,603
0.15 $36,841
X $1,444
0.05 = $4,603
IRR
IRR Solution
(Interpolate)
0.10 $41,444
X $1,444
0.05 IRR $40,000 $4,603
0.15 $36,841
X = ($1,444)(0.05) X = 0.0157
$4,603
IRR = 0.10 + 0.0157 = 0.1157 or 11.57%
AT 10% AT 15%
year C.F PV.F PVCF year C.F PV.F PVCF
1 10,000 0.909 9090 1 10,000 0.870 8700
2 12,000 0.826 9912 2 12,000 0.756 9072
3 15,000 0.751 11250 3 15,000 0.658 9870
4 10,000 0.683 6830 4 10,000 0.572 5720
5 7,000 0.621 4347 5 7,000 0.497 3479
36,841
41430
IRR
IRR Acceptance
Criterion
has determined that the hurdle rate is
13% for projects of this type.
No! The firm will receive 11.57% for

each dollar invested in this project at
a cost of 13%. [ IRR < Hurdle Rate ]
IRRs on the Calculator
We will use the

cash flow registry
to solve the IRR
for this problem
quickly and
accurately!
Actual
Actual IRR
IRR Solution
Solution Using
Using
Your
Your Financial
Financial Calculator
Calculator
Steps in the Process
Step 1: Press CF key
Step 2: Press 2nd CLR Work keys
Step 3: For CF0 Press -40000 Enter  keys
Step 4: For C01 Press 10000 Enter  keys
Step 5: For F01 Press 1 Enter  keys
Actual
Actual IRR
IRR Solution
Solution Using
Using
Your
Your Financial
Calculator
Steps in the Process (Part II)
Step 10:For C04 Press 10000 Enter  keys
Step 11:For F04 Press 1 Enter  keys
Step 14: Press   keys
Step 15: Press IRR key
Step 16: Press CPT key
Result: Internal Rate of Return = 11.47%

IRR
IRR Strengths
Strengths
and
and Weaknesses
Weaknesses
•Accounts for • Assumes all cash
TVM flows reinvested at
the IRR
•Considers all
cash flows • Difficulties with
•Less project rankings and
subjectivity Multiple IRRs
Net
Net Present
Present Value
Value (NPV)
(NPV)
NPV is the present value of an

investment project’s net cash
flows minus the project’s initial
cash outflow.
CF1 CF2 CFn

NPV = + +...+ - ICO
(1+k)1 (1+k)2 (1+k)n
NPV
NPV Solution
Solution
Basket Wonders has determined that the
appropriate discount rate (k) for this
project is 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)
NPV
NPV Solution
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(0.885) + $12,000(0.783) +
$15,000(0.693) + $10,000(0.613) +
$ 7,000(0.543) – $40,000
NPV = $8,850 + $9,396 + $10,395 +
$6,130 + $3,801 – $40,000
= - $1,428
NPV
NPV Acceptance
Criterion
has determined that the required
rate is 13% for projects of this type.
No! The NPV is negative. This means

that the project is reducing shareholder
wealth. [Reject as NPV < 0 ]
NPV on the Calculator
We will use the cash

flow registry to solve
the NPV for this
problem quickly and
accurately!
Hint: If you have not

cleared the cash flows
from your calculator, then
you may skip to Step 15.
Actual
Actual NPV
NPV Solution
Solution Using
Using
Your
Your Financial
Calculator
Steps in the Process
Step 1: Press CF key
Step 2: Press 2nd CLR Work keys
Step 3: For CF0 Press -40000 Enter  keys
Actual
Actual NPV
NPV Solution
Solution Using
Using
Your
Your Financial
Calculator
Steps in the Process (Part II)
Step 14: Press   keys
Step 15: Press NPV key
Step 16: For I=, Enter 13 Enter  keys
Step 17: Press CPT key
Result: Net Present Value = -$1,424.42
NPV
NPV Strengths
Strengths
and
and Weaknesses
Weaknesses
• Cash flows May not include
•
assumed to be managerial
reinvested at the options embedded
hurdle rate. in the project. See
• Accounts for TVM. Chapter 14.
• Considers all
13.33
cash flows.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Net
Net Present
Present Value
Value Profile
Profile
$000s
Sum of CF’s Plot NPV for each
15 discount rate.
Net Present Value
Thre
e of th
10 ese
poin
t s ar
e ea
sy n
5 IRR ow!
NPV@13%
0
-4
0 3 6 9 12 15
Discount Rate (%)
Creating NPV Profiles
Using the Calculator
Hint: As long as you

do not “clear” the
cash flows from the
registry, simply start
at Step 15 and enter
a different discount
rate. Each resulting
NPV will provide a
“point” for your NPV
Profile!
Profitability
Profitability Index
Index (PI)
(PI)
PI is the ratio of the present value of
a project’s future net cash flows to
the project’s initial cash outflow.
Method #1:
CF1 CF2 CFn
PI = + +...+ ICO
(1+k)1 (1+k)2 (1+k)n
<< OR >>
Method #2:
PI = 1 + [ NPV / ICO ]
PI
PI Acceptance
Criterion
PI = $38,572 / $40,000
= .9643 (Method #1, previous slide)
No! The PI is less than 1.00. This

means that the project is not profitable.
[Reject as PI < 1.00 ]
PI
PI Strengths
Strengths
and
and Weaknesses
Weaknesses
• Same as NPV • Same as NPV
• Allows • Provides only
comparison of relative profitability
different scale • Potential Ranking
projects
Problems
Evaluation Summary
Basket Wonders Independent Project

Method Project Comparison Decision
PBP 3.3 3.5 Accept
IRR 11.47% 13% Reject
NPV -$1,424 $0 Reject
PI .96 1.00 Reject
Project
Project Evaluation:
Evaluation: Remember
Remember
Chapter
Chapter 12
12 ‘New
‘New Asset’
Asset’ project?
project?
Year Cash Flow Cumulative CF
We will start with the cash
0 $ (75,000) $ (75,000)
1 $ 33,332 $ (41,668) flows of the project and also
2 $ 36,446 $ (5,222) calculate the cumulative
3
4
$ 28,147
$ 37,075
$
$
22,925
60,000 cash flow values.
We can use Excel functions / approaches to calculate each of

the following methods from the above cash flows.
Discount rate: 16%

PBP: 2.19 Accept: Assume want payback within 3 yrs
IRR: 28.40% Accept: Exceeds discount rate
NPV: $ 19,328.69 Accept: Increase shareholder wealth
PI: 1.26 Accept: Greater than 1.00
Other Project
Relationships
• Dependent – A project whose
acceptance depends on the
acceptance of one or more other
projects.
• Mutually Exclusive – A project whose
acceptance precludes the acceptance
of one or more alternative projects.
Potential
Potential Problems
Problems
Under
Under Mutual
Mutual Exclusivity
Exclusivity
Ranking of project proposals may
create contradictory results.
A. Scale of Investment
B. Cash-flow Pattern
C. Project Life
A.
A. Scale
Scale Differences
Differences
Compare a small (S) and a
large (L) project.
NET CASH FLOWS

END OF YEAR Project S Project L
0 -$100 -$100,000
1 0 0
2 $400 $156,250
A.
A. Scale
Scale Differences
Differences
Calculate the PBP, IRR, NPV@10%,
and PI@10%.
Which project is preferred? Why?
Project IRR NPV PI
S 100% $ 231 3.31

L 25% $29,132 1.29
Remember to refer to Excel spreadsheet
‘VW13E-13b.xlsx’ and the ‘Scale’ tab.
A.
A. Scale
Scale Differences
Differences
Year CF - Small CF - Large
0 $ (100) $ (100,000)
1 $ - $ - Graph the NPV Profiles for 'Small' and 'Large'
2 $ 400 $ 156,250
projects
$350.00 $60,000.00
Discount rate: 10%
IRR: 100.00% 25.00%
$300.00
NPV: $ 230.58 $ 29,132.23 $50,000.00
PI: 3.31 1.29
$250.00
 $40,000.00
BEST!!
Greatest NPV $200.00
$30,000.00
$150.00 NPV - Small
Rate NPV - Small NPV Large NPV Large

$20,000.00
0% $300.00 $56,250.00 $100.00
2% $284.47 $50,182.62
$10,000.00
4% $269.82 $44,461.91 $50.00
6% $256.00 $39,061.94
8% $242.94 $33,959.19 $0.00 $0.00
10% $230.58 $29,132.23 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24%
12% $218.88 $24,561.54
Axis Title
14% $207.79 $20,229.30
16% $197.27 $16,119.20
18% $187.27 $12,216.32
20% $177.78 $8,506.94
22% $168.74 $4,978.50
24% $160.15 $1,619.41 Refer to VW13E-13b.xlsx on the ‘Scale’ tab.
B.
B. Cash
Cash Flow
Flow Pattern
Pattern
Let us compare a decreasing cash-flow (D)
project and an increasing cash-flow (I) project.
NET CASH FLOWS

END OF YEAR Project D Project I
0 -$1,200 -$1,200
1 1,000 100
2 500 600
3 100 1,080
Cash
Cash Flow
Flow Pattern
Pattern
Calculate the IRR, NPV@10%, and
PI@10%.
Which project is preferred?
Project IRR NPV PI

D 23% $198 1.17
I 17% $198 1.17
600 Examine
Examine NPV
NPV Profiles
Profiles
Plot NPV for each
Net Present Value ($)
project at various
Project I discount rates.
400
NPV@10%
200
IRR
Project D
0
-200
0 5 10 15 20 25
Discount Rate (%)
600
Net Present Value ($)
Fisher’s
Fisher’s Rate
Rate of
of Intersection
Intersection
At k<10%, I is best! Fisher’s Rate of

Intersection
-200 0 200 400
At k>10%, D is best!
0 5 10 15 20 25
Discount Rate ($)
‘VW13E-13b.xlsx’ and the ‘Pattern’ tab.
B.
B. Cash
Cash Flow
Flow Pattern
Pattern
Year CF - Decrease CF - Increase
0 $ (1,200) $ (1,200)
1 $ 1,000 $ 100
2 $ 500 $ 600
3 $ 100 $ 1,080
NPV Profiles for two similar projects

Discount rate: 10%
$700.00
IRR: 22.79% 16.93%
NPV: $ 197.45 $ 198.20
$600.00
PI: 1.16 1.17
 $500.00
BEST??
Greatest NPV
$400.00
$300.00
Rate NPV - Decrease NPV Increase NPV - Decrease
0% $400.00 $580.00 NPV Increase
$200.00
2% $355.21 $492.45
4% $312.72 $411.00 $100.00
6% $272.36 $335.13
8% $233.98 $264.33 $0.00
10% $197.45 $198.20 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24%
12% $162.63 $136.32 ($100.00)
14% $129.42 $78.37
16% $97.72 $24.01 ($200.00)
18% $67.41 ($27.02)
20% $38.43 ($75.00)
22%
24%
$10.67
($15.92)
($120.15)
($162.69)
Refer to VW13E-13b.xlsx on the ‘Pattern’ tab.
C.
C. Project
Project Life
Life Differences
Differences
Let us compare a long life (X) project
and a short life (Y) project.
NET CASH FLOWS

END OF YEAR Project X Project Y
0 -$1,000 -$1,000
1 0 2,000
2 0 0
3 3,375 0
Project
Project Life
Life Differences
Differences
Calculate the PBP, IRR, NPV@10%,
and PI@10%.
Which project is preferred? Why?
Project IRR NPV PI
X 50% $1,536 2.54

Y 100% $ 818 1.82
‘VW13E-13b.xlsx’ and the ‘Life’ tab.
C.
C. Project
Project Life
Life Differences
Differences
Year CF - X CF - Y
0 $ (1,000) $ (1,000)
1 $ - $ 2,000
2 $ - $ -
3 $ 3,375 $ -
NPV Profiles for X and Y - neither repeated

Discount rate: 10%
$2,500.00
IRR: 50.00% 100.00%
NPV: $ 1,535.69 $ 818.18
PI: 2.54 1.82
$2,000.00

BEST??
Greatest NPV
$1,500.00
Rate NPV - X NPV - Y NPV - X

0% $2,375.00 $1,000.00 $1,000.00 NPV - Y
2% $2,180.34 $960.78
4% $2,000.36 $923.08
6% $1,833.72 $886.79
$500.00
8% $1,679.18 $851.85
10% $1,535.69 $818.18
12% $1,402.26 $785.71
$0.00
14% $1,278.03 $754.39
16% $1,162.22 $724.14 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24%
18% $1,054.13 $694.92
20% $953.13 $666.67
22% $858.64 $639.34
24% $770.14 $612.90
Another Way to
Look at Things
1. Adjust cash flows to a common terminal
year if project “Y” will NOT be replaced.
Compound Project Y, Year 1 @10% for 2 years.
Year 0 1 2 3
CF –$1,000 $0 $0 $2,420
Results: IRR* = 34.26% NPV = $818

*Lower IRR from adjusted cash-flow stream. X is still Best.
Replacing Projects
with Identical Projects
2. Use Replacement Chain Approach (Appendix B)
when project “Y” will be replaced.
0 1 2 3
–$1,000 $2,000
–1,000 $2,000
–1,000 $2,000
–$1,000 $1,000 $1,000 $2,000
Results: IRR = 100% NPV* = $2,238.17
*Higher NPV, but the same IRR. Y is Best.
Best
‘VW13E-13b.xlsx’ and the ‘Life2’ tab.
C.
C. Project
Project Life
Life Differences
Differences
Year 0 Year 1 Year 2 Year 3
Year CF - X CF - Y
-1000 2000
0 $ (1,000) $ (1,000) -1000 2000
1 $ - $ 1,000 -1000 2000
2 $ - $ 1,000 -1000 1000 1000 2000
3 $ 3,375 $ 2,000
NPV Profiles for X and Y-repeated

Discount rate: 10%
$3,500.00
IRR: 50.00% 100.00%
NPV: $ 1,535.69 $ 2,238.17
PI: 2.54 3.24 $3,000.00

BEST?? $2,500.00
Greatest NPV
$2,000.00
Rate NPV - X NPV - Y NPV - X

0% $2,375.00 $3,000.00 $1,500.00 NPV - Y
2% $2,180.34 $2,826.21
4% $2,000.36 $2,664.09 $1,000.00
6% $1,833.72 $2,512.63
8% $1,679.18 $2,370.93 $500.00
10% $1,535.69 $2,238.17
12% $1,402.26 $2,113.61
$0.00
14% $1,278.03 $1,996.60
16% $1,162.22 $1,886.55 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24%
18% $1,054.13 $1,782.90
20% $953.13 $1,685.19
22% $858.64 $1,592.95
24% $770.14 $1,505.79
Capital Rationing
Capital Rationing occurs when a
constraint (or budget ceiling) is placed
on the total size of capital expenditures
during a particular period.
Example: Julie Miller must determine what
investment opportunities to undertake for
Basket Wonders (BW). She is limited to a
maximum expenditure of $32,500 only for
this capital budgeting period.
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
Choosing by IRRs for BW
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, and E have the
three largest IRRs.
The resulting increase in shareholder wealth
is $27,000 with a $32,500 outlay.
Choosing by NPVs for BW
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.
Choosing by PIs for BW
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.
Summary of Comparison
Method Projects Accepted Value Added
PI F, B, C, and D $38,000
NPV F and G $28,500
IRR C, F, and E $27,000
PI generates the greatest increase in

shareholder wealth when a limited capital
budget exists for a single period.
Single-Point
Single-Point Estimate
Estimate
and
and Sensitivity
Sensitivity Analysis
Analysis
Sensitivity Analysis:
Analysis A type of “what-if”
uncertainty analysis in which variables or
assumptions are changed from a base case in
order to determine their impact on a project’s
measured results (such as NPV or IRR).
• Allows us to change from “single-point” (i.e.,
revenue, installation cost, salvage, etc.) estimates
to a “what if” analysis
• Utilize a “base-case” to compare the impact of
individual variable changes
• E.g., Change forecasted sales units to see
impact on the project’s NPV
Post-Completion Audit
Post-completion Audit
A formal comparison of the actual costs and
benefits of a project with original estimates.
• Identify any project weaknesses

• Develop a possible set of corrective actions
• Provide appropriate feedback
Result: Making better future decisions!
Multiple
Multiple IRR
IRR Problem*
Problem*
Let us assume the following cash flow
pattern for a project for Years 0 to 4:
–$100 +$100 +$900 –$1,000
How many potential IRRs could this
project have?
Two!! There are as many potential
IRRs as there are sign changes.
* Refer to Appendix A
NPV
NPV Profile
Profile –– Multiple
Multiple IRRs
IRRs
75 Multiple IRRs at
Net Present Value
k = 12.95% and 191.15%

50
($000s)
25
–100
0 40 80 120 160 200
Discount Rate (%)
NPV Profile – Multiple IRRs
Hint: Your calculator

will only find ONE
IRR – even if there
are multiple IRRs. It
will give you the
lowest IRR. In this
case, 12.95%.

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Capital Budgeting Techniques Capital Budgeting Techniques

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Chapter 13

PBP is the period of time

–40 K (-b) 10 K 12 K 15 K 10 K(d) 7K

PBP = 3 + ( 3K ) / 10K = 3.3

IRR is the discount rate that equates the

CF1 CF2 CFn

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

Find the interest rate (IRR) that causes the

No! The firm will receive 11.57% for

We will use the

Result: Internal Rate of Return = 11.47%

NPV is the present value of an

CF1 CF2 CFn

No! The NPV is negative. This means

We will use the cash

Hint: If you have not

Hint: As long as you

Should this project be accepted?

No! The PI is less than 1.00. This

Basket Wonders Independent Project

We can use Excel functions / approaches to calculate each of

Discount rate: 16%

NET CASH FLOWS

S 100% $ 231 3.31

Rate NPV - Small NPV Large NPV Large

NET CASH FLOWS

Project IRR NPV PI

At k<10%, I is best! Fisher’s Rate of

NPV Profiles for two similar projects

NET CASH FLOWS

X 50% $1,536 2.54

NPV Profiles for X and Y - neither repeated

Rate NPV - X NPV - Y NPV - X

Results: IRR* = 34.26% NPV = $818

NPV Profiles for X and Y-repeated

Rate NPV - X NPV - Y NPV - X

PI generates the greatest increase in

• Identify any project weaknesses

k = 12.95% and 191.15%

Hint: Your calculator

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