CAPITAL

BUDGETING PART
2
 ANNUAL CAPITAL CHARGE OR
EQUIVALENT ANNUAL COST (EAC)
1. The annual capital charge is a method for evaluating an investment by converting the capital cost to
an annual equivalent and then determining whether the project is acceptable by comparing that charge to the annual net
cash flow it generates.

2. The appraisal criteria used for evaluating mutually exclusive projects

3.  or alternative which provides similar service but have a different pattern of cost and unequal life span.
PRACTICE PROBLEM
Pratfall Airlines Inc. needs to replace a short-haul commuter plane on one of its busy routes.
Plane A has a life of 8 yours
Plane B has a life of 6 years
 the initial outlay and the operating cost (in rupees)  associated with the system are as follows:
Calculate the annual capital charge associated with the two systems if the cost of capital is 15% p.a. 

Year Plane A  Plane B 

0 50 lakhs  45 Lakhs 
1 7  8
2 8 8
3 8.5 12
4 9 12
5 9 14
6  11 15
7 12 -
8 12.5 -
SOLUTION PLANE A
Plane
Year PVIF(15%,n) PV CF
A 
0 50 1 50
1 7 0.869565217 6.08696
2 8 0.756143667 6.04915
3 8.5 0.657516232 5.58889
4 9 0.571753246 5.14578
5 9 0.497176735 4.47459
6 11 0.432327596 4.7556
7 12 0.37593704 4.51124
8 12.5 0.326901774 4.08627
Plane A Sum 90.69848
PVIFA(15%,8) 4.487
Annual Capital Charge 20.21361
Year Plane B  PVIF(15%,n) PV CF
0 45 1 45
1 8 0.869565217 6.956522
2 8 0.756143667 6.049149
3 12 0.657516232 7.890195
4 12 0.571753246 6.861039
5 14 0.497176735 6.960474
6 15 0.432327596 6.484914
7  -    
8 -     
Sum 86.20229
PVIF(15%,6) 3.352
Annual Capital Charge 25.71667
PAYBACK PERIOD
1. Payback =Initial Investment /Annual Cash Flow =500000/125000
PAYBACK PERIOD
0 -20000
1 8000
2 7000
3 4000
4 3000
5 3000
PAYBACK PERIOD SOLUTION
Yr CF Cumulative Value
0 -20000 -20000
1 8000 -12000
2 7000 -5000
3 4000 -1000
4 3000 2000
5 3000 5000

Pay Back
= 3 years +(1000/3000)*12  

  4months
  3 years 4 months  
DISCOUNTED PAYBACK PERIOD
1. Cost of capital is @10%

0 -20000
1 8000
2 7000
3 4000
4 3000
5 3000
DISCOUNTED PAYBACK PERIOD SOLUTION
Ko 15%    

Yr CF PVIF@15% Cumulative Value

0 -20000
-20000 -20000
1 8000
6956.52174 -13043.47826
2 7000
5293.00567 -7750.47259
3 4000
2630.06493 -5120.40766
4 3000
1715.25974 -3405.147923
5 3000
1491.53021 -1913.617717

Here the payback is more than 5 years

ACCOUNTING RATE OF RETURN
1. ROI =Average income(PAT)
Average Investment (Book value of the investment )
EXAMPLE