Capital Budgeting Technique

Class # 7
Session # 19, 20 & 21
 Capital Budgeting Techniques
• Payback period
• Discounted payback period
• Net Present Value
• Internal Rate of Return
• Profitability Index
• Modified Internal Rate of Return
 Payback Period

Payback period in capital budgeting refers to

the time required to recoup the funds expended

in an investment, or to reach the break-even

point. 
Let’s do Question # 1
 DKC CO- Computation for Payback Period
Year Cash flow Accumulated CF
0 ($100,000) ($100,000)
1 20,000 (80,000)
2 30,000 (50,000)
3 40,000 (10,000)
4 50,000 40,000
5 10,000 50,000

Payback Period = Year at last –VE cash flow + (last –ve ACF / next +ve CF) * 365
Payback Period = 3 years + (10,000 / 50,000) x 365
Payback Period = 3 years & 73 days
Let’s do Question # 2
 ABC CO- Computation for Net Present Value

Year Cash flow Discount @10% NPV

0 ($15,000) 1 ($15,000)
1 6,000 0.909 5,454
2 5,000 0.826 4,130
3 4,000 0.751 3,004
4 3,000 0.683 2,049
5 2,000 0.620 1,240
Net Present Value 877
Since the NPV is +ve, project is acceptable
Calculate NPV @ 15%
 ABC CO- Computation for Net Present Value

Year Cash flow Discount @15% NPV

0 ($15,000) 1 ($15,000)
1 6,000 0.869 5,214
2 5,000 0.756 3,780
3 4,000 0.657 2,628
4 3,000 0.571 1,713
5 2,000 0.497 994
Net Present Value -671
Since the NPV is -ve, project is not acceptable
Let’s do Question # 3
Discounted Payback
 DKC CO- Computation for Payback Period
Year Cash flow Dis. CF @10 Acc. CF
0 ($ 15,000) ($ 15,000) ($ 15000)
1 6,000 5,454 (9,546)
2 5,000 4130 (5,416)
3 4,000 3,004 (2,412)
4 3,000 2,049 (363)
5 2,000 1240 877

Payback Period = Year at last –VE cash flow + (last –ve DACF / next +ve DCF) * 365
Payback Period = 4 years + (363 / 1240) x 365
Payback Period = 4 years & 107 days
Let’s do Question # 4
Internal Rate of Return
ABC CO.- Computation for Payback Period

IRR = 10% + (877 / 877 – (-671)) x (15% – 10%)

IRR = 10% + (877 / 877 +671 ) x 5%
IRR = 10% + (877 / 1548) x 5%
IRR = 0.10 + (877 / 1548) x 0.05
IRR = 12.83 % approx
 Do it yourself # 5
Internal Rate of Return
 What is Profitability Index

• The Profitability Index (PI) measures the ratio between the

present value of future cash flows and the initial investment.
The index is a useful tool for ranking investment projects and
showing the value created per unit of investment.
• The Profitability Index is also known as the Profit Investment
Ratio (PIR) or the Value Investment Ratio (VIR).
• PI > 1: Accept ; PI < 1: Reject ; the higher the better
Let’s do Question # 6
Profitability Index
 Computation For Profitability Index – PI (Project Y)
Discount Factor @ 10 %
Year Cash inflow DF @ 10% NPV
1 $ 150,000 0.909 $ 136,350

2 $ 300,000 0.826 $ 247,800

3 $ 500,000 0.751 $ 375,500

4 $ 200,000 0.683 $ 136,600

5 $ 600,000 0.620 $ 372,000

6 $ 500,000 0.564 $ 282,000

7 $ 100,000 0.513 $ 51,300

Net Present Value of Future Cash Flows (NPV) = $ 16,01,550
 Computation For Profitability Index – PI (Project Y)

PI= Total Present Values of Future Cash flows / Initial Investment

PI = 16,01,550 / 15,00,000

PI = 1.0677
Calculate PI of Project Z
 Computation For Profitability Index – PI (Project Z)

PI= Total Present Values of Future Cash flows / Initial Investment

PI = 28,65,800 / 30,00,000

PI = 0.955
Conclusion
Details Project Y Project Z
PI 1.067 0.955
Decision Accept Reject
Let’s do Question # 7
Modified Internal Rate of
Return
Computation For Modified Internal Rate of Return - IRR

Discount Factor @ 10%

Year Cash flow DF @ 10% Present Value
1 $ 400 0.909 $ 364
2 $ 600 0.826 $ 496
3 $ 300 0.751 $ 225
Total Present Value (NPV) = $ 1085
MIRR = (Total PV / Outlay ) 1/life x (1+i) - 1
MIRR = (1085 / 1000) 1/3 x (1+0.1) - 1
MIRR = (1.085) 1/3 x (1.1) - 1
MIRR = (1.027) x (1.1) - 1
MIRR = 1.130 - 1
MIRR = 13 %
Let’s do Question # 8
Modified Internal Rate of
Return
 Home Work
Question # 9 & 10
 End of the Class
Thank You Very Much
Capital Investment
Appraisal

Class # 8
Session: 22, 23 & 24
What is CIA ?
Let’s do Question # 1
Computation of NPV
Mr. Jason - Computation for Cash Inflow- Alan

Year Rent Income Selling Price Tot.

Inflow
0 xxx xxx xxx
1 xxx xxx xxx
2 7 x 5000 xxx 35,000
3 8 x 5000 xxx 40,000
4 10 x 5000 290,000 340,000
Mr. Jason - Computation for Cash Outflow - Alan
Purchase
Year Price Constructio Maintena
n nce Outflow
0 100,000 xxx xxx (100,000)
1 xxx 180,000 xxx (180,000)
12,000 +
2 xxx xxx (15,500)
3500
12,000
3 xxx xxx (16,000)
+4000
12,000 +
4 xxx xxx (17,000)
5000
Mr. Jason - Computation for Cash Inflow- Alan

Year Tot Inflow Tot outflow Cashflow

0 xxx (100,000) (100,000)
1 xxx (180,000) (180,000)
2 35,000 (15,500) 19,500
3 40,000 (16,000) 24,000
4 340,000 (17,000) 323,000
 Mr. Jason - Computation for NPV - Alan

Year Cash flow Dis @10% Dis. CF

0 (100,000) 1 (100,000)
1 (180,000) 0.909 (163,620)
2 19,500 0.826 16,107
3 24,000 0.751 18,024
4 323,000 0.683 220,609
Net Present Value of Future Cash Flows (NPV) = $ (8,880)
Computation of NPV-
using Bob
Estimation
Mr. Jason - Computation for Cash Inflow- BOB

Year Rent Income Selling Price Tot.

Inflow
0 xxx xxx xxx
1 xxx xxx xxx
2 7 x 5000 xxx 35,000
3 8 x 5000 xxx 40,000
4 10 x 5000 315,000 365,000
Mr. Jason - Computation for Cash Outflow - BOB
Purchase
Year Price Constructio Maintena
n nce Outflow
0 100,000 xxx xxx (100,000)
1 xxx 180,000 xxx (180,000)
12,000 +
2 xxx xxx (15,500)
3500
12,000
3 xxx xxx (16,000)
+4000
12,000 +
4 xxx xxx (17,000)
5000
Mr. Jason - Computation for Cash Inflow- BOB

Year Tot Inflow Tot outflow Cashflow

0 xxx (100,000) (100,000)
1 xxx (180,000) (180,000)
2 35,000 (15,500) 19,500
3 40,000 (16,000) 24,000
4 365,000 17,000 348,000
 Mr. Jason - Computation for NPV - Alan

Year Cash flow Dis @10% Dis. CF

0 (100,000) 1 (100,000)
1 (180,000) 0.909 (163,620)
2 19,500 0.826 16,107
3 24,000 0.751 18,024
4 348,000 0.683 237,684
Net Present Value of Future Cash Flows (NPV) = $ 8,195
Mr. Jason - Computation for Sales
Proceed for Zero NPV
NPV = -Inflows + outflows
0 = -263,620 +16,107 +18,024 + X
0 = -263,620 +16,107 +18,024 + X
Dis. SP = 229,489
SP = 229,489 / 0.683
SP = 336,001
SP = 336,001 – 50,000 + 17000
SP = 303,001
Let’s do Question # 2
Computation of NPV
Wong Ho - Computation for NPV

Year Dis. CF
0 (55,000)
1 3683.40
2 6,536.50
3 9,483.75
4 14,977.60
5 21,019.50
Net Present Value (NPV) = $ 700.75
 Wong Ho- Computation for Cash Inflow

Year Present Dis @14%

Value Cashflow
1 3,683.40 0.877 4,200
2 6,536.50 0.769 8,500
3 9,483.75 0.675 14,050
4 14,977.60 0.592 25,300
5 21,019.50 0.519 40,500
 Wong Ho -Computation for Payback Period

Year Cash flow Accumulated CF

0 ($55,000) ($55,000)
1 4,200 (50,800)
2 8,500 (42,300)
3 14,050 (28,250)
4 25,300 (2,950)
5 40,500 37,550

Payback Period = Year at last –VE cash flow + (last –ve ACF / next +ve CF) * 365
Payback Period = 4 years + (2950/ 40,500) x 365
Payback Period = 4 years & 27 days
 Wong Ho- Computation for No. of units

Year SP VC Contribution
Cash flow Units = CF / CM
(SP – VC)
4,200 / 20
1 40 20 20 4,200 => 210
2 40 20 20 8,500 425
3 50 25 25 14,050 562
4 50 25 25 25,300 1012
5 55 25 30 40,500 1350
Let’s do Question # 3
Computation of NPV
 Tisha - Computation for Cashflows
Detail
s 0 1 2 3 4 5
Purchase Price (125,000) XX XX XX XX XX

Scrap Value XX XX XX XX XX 65,000

Inc. Revenue XX 10,000 10,000 10,000 10,000 10,000

Dec. in VC XX 20,000 20,000 20,000 20,000 20,000

Service Fee XX (1,000) XX XX XX XX

Maint. Cost XX (5,000) (5,000) (5,000) (5,000) (5,000)

Total Cashflow (125,000) 24,000 25,000 25,000 25,000 90,000

 Tisha -Computation for Payback Period
Year Cash flow Accumulated CF
0 ($125,000) ($125,000)
1 24,000 (101,000)
2 25,000 (76,000)
3 25,000 (51,000)
4 25,000 (26,000)
5 90,000 64,000

Payback Period = Year at last –VE cash flow + (last –ve ACF / next +ve CF) * 365
Payback Period = 4 years + (26,000 / 90,000) x 365
Payback Period = 4 years & 105 days
 Tisha - Computation for NPV

Year Cash flow Dis @10% Dis. CF

0 (125,000) 1 (125,000)
1 24,000 0.909 21,816
2 25,000 0.826 20,650
3 25,000 0.751 18,775
4 25,000 0.683 17,075
5 90,000 0.621 55,890
Net Present Value of Future Cash Flows (NPV) = $ 9,206
 Tisha - Computation for IRR

IRR = 10% + (9206 / 9206 – (-24,953)) x (20% – 10%)

IRR = 10% + (9206 / 9206 +24,953) x 10%
IRR = 10% + (9206 / 34,159) x 10%
IRR = 0.10 + (9206 / 34,159) x 0.10
IRR = 12.69 % approx
 Home Work
Question # 4 & 5
Quiz # 2 on Friday
Chapter # 6, 7 & 8
 End of the Class
Thank You Very Much