CaplLal 8udgeLlng

-eL resenL value

kequ|red keturn (CpporLunlLy CosL of CaplLal)
LxpecLed raLe of reLurn glven up by lnvesLlng ln a
pro[ecL
Net resent Va|ue resenL value of cash
flows mlnus lnlLlal lnvesLmenLs
-eL resenL value
-v v requlred lnvesLmenL
9
9
7

!'
) 1 (
...
) 1 ( ) 1 (
) (
2
2
1
1
0

9
9
7

!'
) 1 (
) (
0

-eL resenL value
1ermlnology
C Cash llow
L Llme perlod of Lhe lnvesLmenL
r requlred reLurn or opporLunlLy cosL "
W 1he Cash llow could be poslLlve or negaLlve aL any
Llme perlod
-eL resenL value
Net resent Va|ue ku|e Net resent Va|ue ku|e
Managers lncrease shareholders' wealLh by
accepLlng all pro[ecLs LhaL are worLh more
Lhan Lhey cosL
1herefore Lhey should accepL pro[ecLs wlLh a
poslLlve neL presenL value
-eL resenL value
xomple
O 5oppose we coo lovest 550 toJoy tecelve 560
lotet toJoy wbot ls oot locteose lo voloe?
lnlLlal lnvesLmenL
Added value
$30
$10
A roflL $30 + $60
$10
-eL resenL value
xomple
5oppose we coo lovest 550 toJoy ooJ tecelve 560 lo
ooe yeot wbot ls oot locteose lo voloe qlveo o 10
expecteJ tetoto?
1hls ls Lhe deflnlLlon of -v
ProIit -50
60
1.10
$4.55
lnlLlal lnvesLmenL
Added value
$30
$433
-eL resenL value
xomple
oo bove tbe oppottoolty to potcbose oo offlce
bollJloq oo bove o teooot lloeJ op tbot wlll
qeoetote 516000 pet yeot lo cosb flows fot tbtee
yeots At tbe eoJ of tbtee yeots yoo ootlclpote
sellloq tbe bollJloq fot 5450000 wbot ls tbe
moxlmom omooot of mooey yoo woolJ be wlllloq
to poy fot tbe bollJloq qlveo o 7 expecteJ
tetoto?
-eL resenL value
0 1 2 3
$16000 $16000 $16000
$430000
$466000
xomple cootlooeJ
-eL resenL value
0 1 2 3
$16000 $16000 $16000
$430000
$466000
xomple cootlooeJ
resent Va|ue
14933
13973
380393
5409323
-eL resenL value
xomple cootlooeJ
lf tbe bollJloq ls beloq offeteJ fot sole
ot o ptlce of 5J50000 woolJ yoo boy
tbe bollJloq ooJ wbot ls tbe oJJeJ
voloe qeoetoteJ by yoot potcbose ooJ
moooqemeot of tbe bollJloq?
-eL resenL value
xomple cootlooeJ
lf tbe bollJloq ls beloq offeteJ fot sole ot o ptlce of 5J50000
woolJ yoo boy tbe bollJloq ooJ wbot ls tbe oJJeJ voloe
qeoetoteJ by yoot potcbose ooJ moooqemeot of tbe
bollJloq?
!'
!'

50 000
16 000
107
16 000
107
466 000
107
2
1 2

( . )

( . )

( . )
$59
CLher lnvesLmenL CrlLerla
nterna| kate of keturn (kk) ulscounL raLe aL whlch
-v 0
CLher lnvesLmenL CrlLerla
nterna| kate of keturn (kk) ulscounL raLe aL whlch
-v 0
kate of keturn ku|e lnvesL ln any pro[ecL offerlng a
raLe of reLurn LhaL ls hlgher Lhan Lhe opporLunlLy
cosL of caplLal
investment
investment - C
PI
1
CLher lnvesLmenL CrlLerla
lnLernal 8aLe of 8eLurn
nterna| kate of keturn (kk) ulscounL raLe aL
whlch -v 0
xomple
oo coo potcbose o bollJloq fot 5J50000 1be
lovestmeot wlll qeoetote 516000 lo cosb flows (le
teot) Jotloq tbe fltst tbtee yeots At tbe eoJ of tbtee
yeots yoo wlll sell tbe bollJloq fot 5450000 wbot ls
tbe lkk oo tbls lovestmeot?
lnLernal 8aLe of 8eLurn
xomple
oo coo potcbose o bollJloq fot 5J50000 1be lovestmeot wlll qeoetote
516000 lo cosb flows (le teot) Jotloq tbe fltst tbtee yeots At tbe eoJ of
tbtee yeots yoo wlll sell tbe bollJloq fot 5450000 wbot ls tbe lkk oo tbls
lovestmeot?
0 50 000
16 000
1
16 000
1
466 000
1
1 2

( )

( )

( ) ## ## ##
l88 1296
lnLernal 8aLe of 8eLurn

Discount rate (%)
N
P
V

(
,
0
0
0
s
)
l881296
ayback MeLhod
ayback erlod 1lme unLll cash flows recover Lhe
lnlLlal lnvesLmenL of Lhe pro[ecL
ayback MeLhod
ayback erlod 1lme unLll cash flows recover Lhe
lnlLlal lnvesLmenL of Lhe pro[ecL
W 1he poybock tole speclfles LhaL a pro[ecL be accepLed
lf lLs payback perlod ls less Lhan Lhe speclfled cuLoff
perlod 1he followlng example wlll demonsLraLe Lhe
absurdlLy of Lhls sLaLemenL
ayback MeLhod
xomple
1be tbtee ptoject below ote ovolloble 1be compooy occepts
oll ptojects wltb o 2 yeot ot less poybock petloJ 5bow bow
tbls Jeclsloo wlll lmpoct oot Jeclsloo
ayback MeLhod
xomple
1be tbtee ptoject below ote ovolloble 1be compooy occepts
oll ptojects wltb o 2 yeot ot less poybock petloJ 5bow bow
tbls Jeclsloo wlll lmpoct oot Jeclsloo
ash I|ows
r[
0

2

3
ayback NVQ0
A 2000 +1000 +1000 +10000
8 2000 +1000 +1000 0
C 2000 0 +2000 0
ayback MeLhod
xomple
1be tbtee ptoject below ote ovolloble 1be compooy occepts
oll ptojects wltb o 2 yeot ot less poybock petloJ 5bow bow
tbls Jeclsloo wlll lmpoct oot Jeclsloo
ash I|ows
r[
0

2

3
ayback NVQ0
A 2000 +1000 +1000 +10000 2
8 2000 +1000 +1000 0 2
C 2000 0 +2000 0 2
ayback MeLhod
xomple
1be tbtee ptoject below ote ovolloble 1be compooy occepts
oll ptojects wltb o 2 yeot ot less poybock petloJ 5bow bow
tbls Jeclsloo wlll lmpoct oot Jeclsloo
ash I|ows
r[
0

2

3
ayback NVQ0
A 2000 +1000 +1000 +10000 2 +7249
8 2000 +1000 +1000 0 2 264
C 2000 0 +2000 0 2 347
roflLablllLy lndex
ProIitability
Project PV Investment NPV Index
L 4 1 1/.
6 5 1 1/5.20
N 10 7 /7.4
6 2 2/6.
P 5 4 1 1/4.25