Capital budgeting and decision making

Required payback period is calculated using payback

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Unformatted text preview: roblems: Cutoffs are still subjective. Still does not examine all cash flows. Discounted Payback Discounted (500) 250 0 1 250 250 250 250 2 3 4 Discounted Discounted Year Cash Flow Cash 0 1 -500 250 CF (14%) -500.00 219.30 219.30 5 Discounted Payback Discounted (500) 250 0 1 250 250 250 250 2 3 4 5 Discounted Discounted Year Cash Flow Cash 0 1 -500 250 CF (14%) -500.00 219.30 219.30 280.70 280.70 1 year year Discounted Payback Discounted (500) 250 0 1 250 250 250 250 2 3 4 5 Discounted Discounted Year Cash Flow Cash 0 1 -500 250 2 250 CF (14%) -500.00 219.30 219.30 280.70 280.70 192.37 192.37 1 year year Discounted Payback (500) 250 0 1 250 250 250 250 2 3 4 5 Discounted Discounted Year Cash Flow Cash 0 1 -500 250 2 250 CF (14%) -500.00 219.30 219.30 280.70 280.70 192.37 192.37 88.33 88.33 1 year year 2 years years Discounted Payback Discounted (500) 250 0 1 250 250 250 250 2 3 4 5 Discounted Discounted Year Cash Flow Cash 0 1 -500 250 2 250 3 250 CF (14%) -500.00 219.30 219.30 280.70 280.70 192.37 192.37 88.33 88.33 168.74 1 year year 2 years years Discounted Payback Discounted (500) 250 0 1 250 250 250 250 2 3 4 5 Discounted Discounted Year Cash Flow Cash 0 1 -500 250 2 250 3 250 CF (14%) -500.00 219.30 219.30 280.70 280.70 192.37 192.37 88.33 88.33 168.74 1 year year 2 years years .52 years .52 Discounted Payback Discounted (500) 250 0 1 250 250 250 250 2 3 4 5 Discounted Discounted Year Cash Flow CF (14%) Cash Discounted The 0 1 2 3 -500 ayback -500.00 P 250 219.30 219.30 is 2.52 years 280.70 280.70 250 192.37 192.37 88.33 88.33 250 168.74 1 year year 2 years years .52 years .52 More Ex: Discounted payback period period Uses discounted cash flows rather than raw Uses CFs. CFs. 0 CFt PV of CFt Cumulative -100 -100 -100 Disc PaybackL = 2 + 1 2 10 9.09 -90.91 10% 60 49.59 -41.32 41.32 / 60.11 2.7 3 80 60.11 18.79 = 2.7 years Other Methods Other 1) Net Present Value (NPV) 1) Net 2) Profitability Index (PI) 2) Profitability 3) Internal Rate of Return (IRR) 3) Internal Consider each of these decision-making Consider criteria: (to solve PB problem) (to All net cash flows. The time value of money. The required rate of return. Net Present Value • NPV = the total PV of the annual net cash flows - the initial outlay. n NPV = Σ t=1 FCFt FCF (1 + k) t - IO Net Present Value Net Decision Rule: • If NPV is positive, accept. If accept • If NPV is negative, reject. If reject NPV Example NPV Suppose we are considering a capital Suppose investment that costs $250,000 and $250,000 provides annual net cash flows of $100,000 for five years. The firm’s $100,000 required rate of return is 15%. 15% NPV Example NPV Suppose we are considering a capital Suppose investment that costs $250,000 and $250,000 provides annual net cash flows of $100,000 for fi...
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