7-3040 2010 capital budgeting - CAPITAL BUDGETING PROFIT ANALYSIS Profit Measures 1 1 1 Payback Net Present Value(NPV Internal Rate of Return(IRR

7-3040 2010 capital budgeting - CAPITAL BUDGETING PROFIT...

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CAPITAL BUDGETING PROFIT ANALYSIS
Profit Measures 1. Payback 1. Net Present Value (NPV) 1. Internal Rate of Return (IRR)
Investment B - non-annuity cash flows Investment cost $20,000 Year Cash Inflow Cumulative Cash Flow 1 $10,000 2 6,000 3 3,000 4 2,000 5 1,000 6 1,000
Investment B - non-annuity cash flows Investment cost $20,000 Year Cash Inflow Cumulative Cash Flow 1 $10,000 $10,000 2 6,000 16,000 3 3,000 19,000 4 2,000 1,000/2,000 = 0.5 years 5 1,000 6 1,000 Payback period = 3.5 years
Payback’s Problems: 1. It does not measure profitability 2. It does not consider cash flows beyond the payback period 3. It does not use time value adjustments Investment 0 1 2 3 4 5 A -$10,000 5,000 5,000 B -$10,000 5,000 5,000 C -$10,000 5,000 5,000 Payback method ranks all equally, at 2 years
Payback’s Problems: 1.It does not measure profitability2.It does not consider cash flows beyond the payback period3.It does not use time value adjustmentsInvestment 0 1 2 3 A -$10,000 5,000 5,000B -$10,000 5,000 5,000 5,000C -$10,000 5,000 5,000 5,000 5,000 Payback method ranks all equally, at 2 yearsEven though the payback periods are equal are these three investments equally good? 4 5 5,000
NPV & IRR

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