ST 11-1
a) Capital Budgeting is a process of planning related to long term investment or projects that requires a huge amount to be
company evaluates that funds are worthy to invest in that project and which source of funding is better to raise funds so tha
Strategic business plan is such type of plan or strategy that is formulated to achieve overall goals set by a business. . It is for
b) Net present value is the difference between the present value of cash inflows and the present value of cash outflows ove
profitability of a projected investment or project.
c) Internal Rate of return is a method of analysing profitability of a project by using the discount rate that makes the net pre
investment. A company will decide to either accept or reject a project on the basis of this method only.
d) NPV profile is a graphical presentation that shows the relationship between a project's NPV and the firm's cost of capital.
internal rate of return.
Crossover rate is that rate or percentage of cost of capital at which the net present values of two projects are equal. In this,
crossover rate.
e) Mutually-exclusive projects are those set of projects out of which only one project can be selected for investment becau
Independent projects are projects that are not related to each other and each project is evaluated based on its own profita
f) Non-normal cash is a pattern of cash flows in which the direction of cash flows keeps changing. It is also known as unconv
In Normal cash flows, cash flows does not keep on changing frequently and comprises initial investment outlay and then po
Multiple IRRs means a project having more than one internal rate of return and it arises when a project has non-normal ca
g) Modified internal rate of return (MIRR) is modified from of the internal rate of return (IRR) and resolves problems with t
h) Payback period refers to the amount of time required to recover the cost of an investment. Simply it tells the length of ti
ST 11-2
Year Cash Inflow (x) Cash inflow (y) PV of cash inflow (x)
n cash inflow /
1 $6,500 $3,500 〖 (1+𝑘) 〗 ^𝑛 $5,803.57
2 $3,000 $3,500 $2,391.58
3 $3,000 $3,500 $2,135.34
4 $1,000 $3,500 $635.51
Present value of cash inflow = $10,966.00
NPV = Total cash outflows – Present value of Cash inflows
NPV (x) = 10000 - 10966
NPV (x) = 966
NPV (y) = 10000 -10630.72
NPV (y) = 631
IIR (x) = 6500/(1+x)^1 + 3000/(1+x)^2 + 3000/ (1+x)^3 + 1000/(1+x)^4 -10000 = 0
IRR(x) = 18%
IIR (y) = 3500/(1+x)^1 + 3500/(1+x)^2 + 3500/ (1+x)^3 + 3500/(1+x)^4 -10000 = 0
IIR (y)= 15%
PV= TV/(1+MIRR)^n
PV => is negative cash flow
TV => is positive cash flow
PV= $10000
TV =
6500 * 1.12 * 1.12 *1.12 = $9,132.03
3000 * 1.12 * 1.12= $3,763.20
3000 * 1.12 = $3,360
1000 = $1,000
TV = $17,255.23
MIRR = {(17255.23 / 10000)^1/4} - 1 = 0.1461 *100 = 14.61%
MIRR (x) = 14.61%
MIRR(y) = 13.73%
Payback period of X = 6500 + 3000 = 9500
remaining 500 = 500/3000 = 0.16
So, payback period = 2 year + .16 = 2.16 years
Payback (X) = 2.16years
Payback (y) = 3500 * 2= 7000
remaining = 3000/3500 = .85
so, payback period =2 years +0.85 years
Payback (y) = 2.85 years
B) Both Projects can be accepted if they are independent as both are giving good returns and returns are higher.
c) Project X should be accepted if projects are mutually exclusive as Project X
is yielding higher returns in each method whether it is NPV, IRR or MIRR
than Project Y and these methods are considered crucial in taking decisions.
Problem 11-7
a.
Project M
NPV:
By discounting the future cashflows
NPV = -30000 + 10000/(1+0.14)^1 + 10000/(1+0.14)^2 + 10000/(1+0.14)^3 + 10000/(1+0.14)^4 + 10000/(1+0.14)^5
NPV = 4330.81
IRR:
IRR is the rate at which NPV = 0
0 = -30000 + 10000/(1+0.r)^1 + 10000/(1+r)^2 + 10000/(1+r)^3 + 10000/(1+r)^4 + 10000/(1+r)^5
r = 0.1986 = 19.86%
MIRR:
MIRR = [fv of cashflows/Initial investment]^(1/n) - 1
FV = 10000*(1+0.14)^4 + 10000*(1+0.14)^3 + 10000*(1+0.14)^2 + 10000*(1+0.14)^1 + 10000*(1+0.14)^0
FV = 66101.04
MIRR = ((66101.04)/30000)^(1/5) - 1 = 0.1712 = 17.12%
Payback:
Payback period = Initial investment/Yearly cashflow = 30000/10000 = 3years
Discounted payback:
Rate 0.14
Year(n) Cashflow (A) Discount rate = 1/(1+r)^(n) Present Value = A*discount rate
0 -30000 1 -30000
1 10000 0.877192982 8771.93
2 10000 0.769467528 7694.68
3 10000 0.674971516 6749.72
4 10000 0.592080277 5920.8
5 10000 0.519368664 5193.69
DCP = 4 + 862/5193.69 = 4.17 years
Project N:
NPV:
By discounting the future cashflows
NPV = -90000 + 28000/(1+0.14)^1 + 28000/(1+0.14)^2 + 28000/(1+0.14)^3 + 28000/(1+0.14)^4 + 28000/(1+0.14)^5
NPV = 6126.27
IRR:
IRR is the rate at which NPV = 0
0 = -90000 + 28000/(1+0.r)^1 + 28000/(1+r)^2 + 28000/(1+r)^3 + 28000/(1+r)^4 + 28000/(1+r)^5
r = 0.1680 = 16.8%
MIRR:
MIRR = [fv of cashflows/Initial investment]^(1/n) - 1
FV = 28000*(1+0.14)^4 + 28000*(1+0.14)^3 + 28000*(1+0.14)^2 + 28000*(1+0.14)^1 + 28000*(1+0.14)^0
FV = 185082.92
MIRR = ((185082.92)/90000)^(1/5) - 1 = 0.1551 = 15.51%
Payback:
Payback period = Initial investment/Yearly cashflow = 90000/28000 = 3.21years
Discounted payback:
Rate 0.14
Year(n) Cashflow (A) Discount rate = 1/(1+r)^(n) Present Value = A*discount rate
0 -90000 1 -90000
1 28000 0.877192982 24561.4
2 28000 0.769467528 21545.09
3 28000 0.674971516 18899.2
4 28000 0.592080277 16578.25
5 28000 0.519368664 14542.32
DCP = 4 + 8416.06/14542.32 = 4.58 years
b.
If projects are mutually exclusive, then both the projects could be accepted.
In both case, NPV is positive
IRR and MIRR is greater than the required rate of return
Payback period and discounted payback period are lesser than the project life.
c. Though IRR & MIRR is lesser, payback and discounted payback periods are more than project N, considering NPV project N s
d.
The conflict between NPV and IRR is because the size of the investment and cashflows are different even thought the timing is
ST 11-1
ojects that requires a huge amount to be invested. These decisions involves like buying machinery or plant, building or any big project. A
e of funding is better to raise funds so that company can earn higher returns than it will pay on funds raised.
ve overall goals set by a business. . It is formulated for future purpose where a business want to go or till that level business wants to flouris
nd the present value of cash outflows over a period of time. It is also a method of capital budgeting and investment planning to analyze the
g the discount rate that makes the net present value of all cash flows (both positive and negative) equal to zero for a specific project or
of this method only.
roject's NPV and the firm's cost of capital. The point where a project's net present value profile crosses the horizontal axis indicates a proje
t values of two projects are equal. In this, NPV profile of one project crosses over (intersects) the NPV profile of the other project, so it is ca
ect can be selected for investment because decision to undertake one project from mutually exclusive projects effects other projects as we
ject is evaluated based on its own profitability. Acceptance and rejection of one project is independent of other.
keeps changing. It is also known as unconventional cash flow.
rises initial investment outlay and then positive net cash flow throughout the project life. It is also called conventional cash flow stream.
arises when a project has non-normal cash flow patterns.
return (IRR) and resolves problems with the IRR and it is used in capital budgeting to rank alternative investments of equal size.
investment. Simply it tells the length of time which is needed to cover a project's initial cost.
PV of cash inflow (y)
cash inflow /
〖 (1+𝑘) 〗 ^𝑛$3,125
$2,790.18
$2,491.23
$2,224.31
$10,630.72
urns and returns are higher.
1+0.14)^4 + 10000/(1+0.14)^5
000/(1+r)^5
+ 10000*(1+0.14)^0
Cummulative
-30000
-21228.07
-13533.39
-6783.68
-862.88
4330.81
1+0.14)^4 + 28000/(1+0.14)^5
000/(1+r)^5
+ 28000*(1+0.14)^0
Cummulative
-90000
-65438.6
-43893.51
-24994.3
-8416.06
6126.27
an project N, considering NPV project N should be chosen, since it is higher for project N. NPV is considered as inherent reinvestment assu
ws are different even thought the timing is same.
lding or any big project. A
vel business wants to flourish.
ment planning to analyze the
for a specific project or
zontal axis indicates a project's
the other project, so it is called
effects other projects as well.
r.
ntional cash flow stream.
nts of equal size.
inherent reinvestment assumption.
