Capital Budgeting Techniques for Investment Appraisal

Running Head: Appraisal of Capital Investments
Capital Budgeting Techniques

Appraisal of Capital Investments 1
Question 1:
Part a)
i. NET PRESENT VALUE
Investment 1
YEAR
CASH
INFLOWS
CASH
OUTFLOWS NET CASH FLOWS
PVF
@12.50%
PRESENT
VALUE OF
CASHFLOWS
0
$
-
$
46,00,000.00
$ -
46,00,000.00 1.000
$ -
46,00,000.00
1
$
16,00,000.00
$
6,00,000.00
$
10,00,000.00 0.889
$
8,88,888.89
2
$
20,00,000.00
$
5,00,000.00
$
15,00,000.00 0.790
$
11,85,185.19
3
$
24,00,000.00
$
6,00,000.00
$
18,00,000.00 0.702
$
12,64,197.53
4
$
22,00,000.00
$
8,00,000.00
$
14,00,000.00 0.624
$
8,74,013.11
5
$
18,00,000.00
$
10,00,000.00
$
8,00,000.00 0.555
$
4,43,943.17
NPV $ 56,227.88
Investment 2
YEAR
S
CASH
INFLOWS
CASH
OUTFLOWS
NET CASH
FLOWS PVF
PRESENT
VALUES
0
$
-
$
40,00,000.00
$ -
40,00,000.00 1.000
$ -
40,00,000.00
1
$
14,00,000.00
$
6,00,000.00
$
8,00,000.00 0.889
$
7,11,111.11
2
$
18,00,000.00
$
5,00,000.00
$
13,00,000.00 0.790
$
10,27,160.49
3
$
22,00,000.00
$
6,00,000.00
$
16,00,000.00 0.702
$
11,23,731.14
4
$
20,00,000.00
$
8,00,000.00
$
12,00,000.00 0.624
$
7,49,154.09
5
$
16,00,000.00
$
10,00,000.00
$
6,00,000.00 0.555
$
3,32,957.37
NPV $ -55885.79

Appraisal of Capital Investments 2
ii. INTERNAL RATE OF RETURN
Investment 1
Trial Runs Table
NET CASH FLOWS PVF@13% PV
PVF
@13.5% PV
$ -
46,00,000.00 $ 1.000
$ -
46,00,000.00 1.000
$ -
46,00,000.00
$
10,00,000.00 $ 0.885
$
8,84,955.75 0.881
$
8,81,057.27
$
15,00,000.00 $ 0.783
$
11,74,720.03 0.776
$
11,64,392.87
$
18,00,000.00 $ 0.693
$
12,47,490.29 0.684
$
12,31,076.16
$
14,00,000.00 $ 0.613
$
8,58,646.22 0.603
$
8,43,615.58
$
8,00,000.00 $ 0.543
$
4,34,207.95 0.531
$
4,24,727.79
$
20.24
$ -
55,130.34
IRR Formula= Lower Rate + NPV at Lower Rate X (Upper Rate – Lower Rate)
NPV at Lower Rate- NPV at Upper Rate
= 0.13+ 20.24 x (0.1350-0.13) = 13% Approximately
20.24+55130.34
Investment 2
Trial Runs Table
NET CASH FLOWS PVF@12% PV
PVF
@11% PV
$ -
40,00,000.00 1.000
$ -
40,00,000.00 1.000
$ -
40,00,000.00
$
8,00,000.00 0.893
$
7,14,285.71 0.901
$
7,20,720.72
$
13,00,000.00 0.797
$
10,36,352.04 0.812
$
10,55,109.16
$
16,00,000.00 0.712
$
11,38,848.40 0.731
$
11,69,906.21
$
12,00,000.00 0.636
$
7,62,621.69 0.659
$
7,90,477.17
$
6,00,000.00 0.567
$
3,40,456.11 0.593
$
3,56,070.80
$ -
7,436.04
$
92,284.06

Appraisal of Capital Investments 3
IRR FORMULA= 0.13+ 7436.04 x (0.12-0.11) = 11.92% Approximately
92284.06+7436.04
iii. PAYBACK PERIOD
Investment 1
Table for discounted payback period
YEARS NET CASH FLOWS PVF
PRESENT
VALUE OF
CASHFLOWS
CUMULATIVE
PV OF
CASHFLOWS
0
$ -
46,00,000.00 1.000
$ -
46,00,000.00
$ -
46,00,000.00
1
$
10,00,000.00 0.889
$
8,88,888.89
$ -
37,11,111.11
2
$
15,00,000.00 0.790
$
11,85,185.19
$ -
25,25,925.93
3
$
18,00,000.00 0.702
$
12,64,197.53
$ -
12,61,728.40
4
$
14,00,000.00 0.624
$
8,74,013.11
$ -
3,87,715.29
5
$
8,00,000.00 0.555
$
4,43,943.17
$
56,227.88
PAYBACK
PERIOD 4.87 years
Payback period =4 + -3, 87,715.29
4, 43,943.17
=4.87 Years
Investment 2
Note: As the NPV of the Investment 2 is negative, it would not have any Payback period as the cost
of the initial investment would not be recovered during the entire project life.
iv. ANNUAL RATE OF RETURN
ARR = Average net income after depreciation and taxes
Initial investment