Capital Budgeting
1
Byron E. Ferguson
FIN 301 – Principles of Finance
Module 4 Case
Dr. John Halstead
September 18, 2010
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Capital Budgeting
2
Ways to make Capital Budgeting Decisions
The goal of this module is to describe the Capital Budgeting process.
Part I. Capital
Budgeting Problems:
A.
Project expected cash flows;
Year
Cash Flow
Formula:
NPV =
Rt
/ (1+
i
)
t
0
500,000
t
 time of the cash flow
1
$100,000
i
 discount rate
2
$110,000
Rt
 the net cash flow at time or
t
3
$550,000
*Cash inflow and outflow is discounted back to present value (PV); they are summed, therefore
NPV is the sum of all terms listed above at each rate below.
If the discount rate is 0%, what is the project’s net present value? 500,000
If the discount rate is 4%, what is the project’s net present value? 186,803.01
If the discount rate is 8%, what is the project’s net present value? 123,507.59
If the discount rate is 10%, what is the project’s net present value? 95,041.32
What is this project’s internal rate of return? About 15%
The graph illustrates as the discount rate increases, the net present value decreases.
Additionally, based on the downward trend were the curve intersects the horizontal axis at about
15%, which is the IRR (the discount rate that causes NPV to equal $0.00).
If the discount rate is
higher than 15%, project would have a negative NPV and should be rejected.
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 Spring '11
 DR.GARYHANNEY
 Net Present Value, Internal rate of return

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