Capital Budgeting Techniques

Front 1

What are the four methods of a project evaluation and selection in capital budgeting

Back 1

Payback Period (PBP): Net Present Value (NPV): Internatl Rate or Return (IRR); Profitibility Indes (PI)

Front 2

What is Payback Period (PBP) mean?

Back 2

The period of time required for the cumulative expected cash flows from an investment project to equal the initial outflow

Front 3

What does Net present Value (NPV) mean?

Back 3

The present value of an investment project's nec cash flows minus the project's initial cash outflow.

Front 4

What does the internal rate of return (IRR) mean?

Back 4

The discount rate that equates the present value of the future net cash flows from an investment project with the project's initital cash outflow.

Front 5

Explain Profitibility index method (PI)

Back 5

The ration of the present value of a project's future cash flows to the project's initital cash outflow.

Front 6

When should you accept a project payback?

Back 6

if the payback period calculated is less than some maximum acceptable payback period (the cutoff number of period).

Front 7

PBP Example - CF -9,400, 3,400, 3,920, 3,880, 3,600. If the initial investment can be recovered within 2 years, the management will accept the project. Computate

Back 7

After 2 years, CF -2080. Earnings in year 2 are 3,920. 2080/3880 = .536. 2.536 years to recover investment. 2.536>2. Reject

Front 8

PBP Example - CF -18,000, 6,393, 7,549, 5,445, 4853. If the initial investment can be recovered within 3 years, the management will accept the project. Computate

Back 8

Cumulative cash flow shows profit in year three. Accept. 4,058 (debt in year 2)/5,445 (cf in 3rd year) = 2.75. 2.75<3

Front 9

NPV example --9,400, 3,400, 3,920, 3,880, 3,600. Required rate of return = 10% Calculate.

Back 9

Use calculator list and cash flow option. 2304.52 > 0. Accept

Front 10

NPV example CF -18,000, 6,393, 7,549, 5,445, 4853. Required rate of return = 12%. Calculate

Back 10

Use calculator list and cash flow option. 685.86 > 0. Accept

Front 11

IRR example - CF = -9400, 3400, 3920, 3880, 3600. Required Rate of Return is 10%

Back 11

Use cash flows and list, and IRR feature
20.76% > 10% Accept.

Front 12

What's the difference in return figures between NPV and IRR methods.

Back 12

NPV method rate of return = to the firm's opportunity cost of the capital invested. IRR method rate of return = expected return of a project.

Front 13

IRR example - CF = -18,000, 6393, 7549, 5445, 4853. Required Rate of Return is 12%

Back 13

Use cash flows and list and use IRR feature. 13.90>12%. Accept

Front 14

PI example - CF = -9400, 3400, 3920, 3880, 3600. Expected return is 10% Calculate PI.

Back 14

Use cash flows and list. Calculate NPR without the initial investment outflow. Take that # and divide by the absolute value of the initial investment. 1.245 > 1

Front 15

PI example - CF = -18,000, 6393, 7549, 5445, 4853. Expected return is 12% Calculate PI.

Back 15

Use cash flows and list. Calculate NPR without the initial investment outflow. Take that # and divide by the absolute value of the initial investment. 1.04 > 1

Front 16

Which types of units do the four methods use?

Back 16

PBP - years
NPV - dollars
IRR - Percentage
PI - Times

Front 17

What are the three problems with PBP?

Back 17

It ignores cash flows occuring after expiration of the payback period. It ignores the time value of money-it doesn't discount the future money to the present-cutoff point is a subjective decision.

Front 18

Define an independant project.

Back 18

A project whose acceptance (or rejection) does not prevent the acceptance of other projects under consideration.

Front 19

Define a mutually exclusive project.

Back 19

A project whose acceptance precludes the acceptance of one or more alternative projects. So you will rank different projects and then choose a better-ranked project

Front 20

NPR IRR and PI methods will be the same or different for Independant projects? Mutually exclusive projects?

Back 20

Independant = Same. Mutually exclusive projects = may be different.

Front 21

For mutually exclusive projects, what three factors will cause contradictory results?

Back 21

Size of initial cash outflow. Cashflow distribution pattern (timing, increasing, decreasing. And project life.