In this paper, various capital budgeting techniques are calculated from the given data which help the financial and project managers to analyze to whether pursue and accept any given project or not . In other words, these techniques depict the idea attempting to magnify the feasibility of any project to create value for the business . These Techniques are mentioned and calculated as follows using the MS-Excel spreadsheet the calculations of which are shown in the Appendix section:
It is important to mention that to compute the internal rate of return (IRR), the net present value were computed using two different rates of return of 10 and 16 percent . The resulting values were arranged to be used in an interpolation formula to compute IRR which equates the Net Present Value (NPV) of a project to its Initial Investment . The calculations and formulas are presented in the appendix section of this research paper, as stated earlier.
References
Ehrhardt, M., & Brigham, E. (2008). Corporate Finance: A Focused Approach. Cengage Learning.
Gitman, L. J., Juchau, R., & Flanagan, J. (2010). Principles of Managerial Finance. Pearson Higher Education AU.
Jain, K. &. (2007). Financial Management. Tata McGraw-Hill Education.
Marzec, E. (n.d). Three Primary Methods Used to Make Capital Budgeting Decisions. Retrieved December 17, 2014, from The Houston Chronicle: http://smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting-decisions-11570.html
Appendices
Appendix 1 – Payback Period (PBP)
Since all the cash inflows are same throughout the period of six years, the following formula is used:
Payback Period = Initial Investment / Annual Cash Inflow
Payback Period = $80,000 / $20,000 = 4 years
Appendix 2 – Net Present Value
Net Present Value = Total Present Value of all cash inflows minus Initial Investment
= [$20,000 / (1.10^1) + $20,000 / (1.10^2) + $20,000 / (1.10^3) +
$20,000 / (1.10^4) + $20,000 / (1.10^5) + $20,000 / (1.10^6)] - $80,000
= ($18,181.82 + $16,528.93 + $15,026.30 + $13,660.27 + $12,418.43 +
$11,289.48) - $80,000
= $87,105.21- $80,000
Net Present Value = $7,105.21
Appendix 3 – Profitability Index (P.I.)
PI = Initial Investment / Total Present Value of all cash inflows
PI = $80,000 / $87,105.21
PI = 0.9184
Appendix 4 – IRR Interpolation
IRR = Lowest Discount Rate + [(Higher Rate - Lower Rate) × NPV at Lower rate)]
(NPV at Lower Rate - NPV at Higher Rate)
= 0.10 + (0.06 × $7,105.21)
$7,105.21 - $6,305.28
= 0.10 + (0.06 × $7,105.21)
$7,105.21 – (- $6,305.28)
= 0.10 + [$426.3126 / ($7,105.21 + $6,305.28)]
= 0.10 + ($426.3126 / $13,410.49)
IRR = 13.1789%
