Capital Budgeting: Net Present Value and Internal Rate of Return

This report focuses on net present value and internal rate of return for in-house development and outsourcing departments. It analyzes costs and benefits and provides recommendations.

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Introduction
Capital budgeting is one of the techniques that are used to not only measure the financial
performance of the business but also helps the management as well as the investor of the
company to make the decision. At times there are different techniques which are used by the
management in order to be the sure whether the proposal shall be accepted or rejected. The
different techniques include the Net present value, internal rate of the return, profitability (Ng &
Beruvides, 2015).
This report majorly focuses on net present value and the internal rate of return for the in
house development department and the outsourcing department. There are different costs that
have been analyzed for the in house development and the outsource department which can be
bifurcated below.
Cost for in-house development
Hardware
Team salary
Training and Development
Telecommunication and skills
Rent Expense
contingencies
Software Costs
These are the costs for the sources and the benefits realized against the cost are
determined below.
Benefits
Outsourced expenses
supply chain and value chain
Sales
Professional fees
Similar is the case for the outsource department with some different costs which have
been outlined below.
Costs for outsource
Fee for annual license and
installations

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Hardware
software
Training
Telecommunications
Maintenance and consulting fee
Development of software
With the help of these costs the net present value of both the department is calculated. In
case of capital budget, the net present value literally determines the difference between the
present value of the annual cash flows and the cost incurred to take the equipment. This criterion
is important to determine as the management feels that the value of 1 dollar at present is worth
more than that of the future. The net present value is calculated using the discounted factor of the
cost of capital. NPV helps in boosting the company's esteem (Adusumilli, Davis & Fromme,
2016).
Internal rate of return is a rate at which the projects are measured to decide whether they
shall be accepted or rejected. The term internal determines that only internal factors are utilized
for the purpose of the calculation. It is also termed as the discounted cash flow of return. There
are certain reasons as to why the company chose the method of IRR to describe whether the
proposal shall be accepted or else rejected. Since the internal rate of return method considers the
concept of the time value of money even when the annual cash flows are uneven, it determines
the accurate result. The cash flows of both the department are uneven in this case study as well.
Thus, Internal Rate of Return strategy is extraordinary to Net Present Value technique. Here and
there, the pre-assurance of expense of capital is exceptionally troublesome. The productivity of
the task is also considered over the whole financial period of the undertaking (Patrick & French,
2016).
Both of these techniques have been applied in case of the in house department as well as
the outsource department and the following results have been arrived.
PARTICULARS In house Outsource
Net present value 1576509 1229437
IRR 11% 9%

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As it can be observed form the table the net present value of the in house department is
$1576509, whereas the internal rate of return accounts for 11%. While in comparison to the
outsource department the NPV is positive at $1229437, yet the internal rate of return is 9% only.
This suggest that the in house department is suitable for the organization as it has positive Net
present value and the internal rate of return is also higher that the cost of capital at 8%. Not only
in the basis of these figures, has the in house department had low projects costs and higher
benefits realized. On the other hand in case of the outsource department, the costs are really high
for outsourcing and the benefits are also not reaped equally. Further the graph of the discounted
cash flow also suggests that in case of the in house the annual cash flows tends to be positive
more rather than the outsource department.
2016
2017
2018
2019
2020
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Discounted cash flow
In house
Outsource
The internal rate of return of both the departments is greater than the cost of capital,
however higher the rate of return the better results are provided to the company. The proposal of
both the departments can be accepted but when compared on the basis of the costs, the
outsource department tends to be more costly and the benefits are less. Despite the IRR is higher
than the cost of capital, the company will take enough time to pay back for the costs incurred. In
case of the in house department the costs are low and therefore the company is more in favor of
selecting the in house proposal (Petković, et al 2016).

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Henceforth, from the overall analysis it can be concluded that though both of the projects
have positive Net present value and the higher internal rate of return yet the in house proposal is
only suitable to the company. The outsource proposal can be suitable only when there are limited
costs and higher benefits reaped. Just on the basis of positive net present value and the higher
internal rate of return ideally one cannot select the proposal, a combination of other valuation
techniques are also applied to enforce the right decision making. Hence, it is advised that the
company shall select the in house proposal.

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References
Adusumilli, N., Davis, S., & Fromme, D. (2016). Economic evaluation of using surge valves in
furrow irrigation of row crops in Louisiana: A net present value approach. Agricultural
Water Management, 174, 61-65.
Ng, E. H., & Beruvides, M. G. (2015). Multiple internal rate of return revisited: frequency of
occurrences. The Engineering Economist, 60(1), 75-87.
Patrick, M., & French, N. (2016). The internal rate of return (IRR): projections, benchmarks and
pitfalls. Journal of Property Investment & Finance, 34(6), 664-669.
Petković, D., Shamshirband, S., Kamsin, A., Lee, M., Anicic, O., & Nikolić, V. (2016).
RETRACTED: Survey of the most influential parameters on the wind farm net present
value (NPV) by adaptive neuro-fuzzy approach.