Capital Budgeting: Evaluate 3 Projects with the 6 Capital Budgeting Tools
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Evaluate the following 3 projects with all of the 6 capital budgeting tools (Net Present Value, Internal rate of Return, Profitability Index, Payback Period, Discount Payback Period, Modified Internal rate of Return). Which projects would you approve? If you could do only one (assume the most you have to invest is $500), which one would you choose and why? in other words, which project would you pick as the best:
Projected
Cash Flow Years 0 1 2 3 4 5
Project A (500) 45 55 65 175 185
Project B (250) 85 65 55 45 100
Project C (400) 175 75 75 175 25
Use 10% as the discount rate and WACC (and the IRR/MIRR hurdle rate)
*Year 0 is your initial cost outlay -- the cost of the project.
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Solution Summary
This solution provides step by step calculations of NPV, IRR, profitability index, payback period, discounted payback period, and MIRR in an attached Excel file.
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Project A Project B Project C
Cash Flow Years Cash Flow Cash Flow Years Cash Flow Cash Flow Years Cash Flow
0 -500 0 -250 0 -400
1 45 1 85 1 175
2 55 2 65 2 75
3 65 3 55 3 75
4 175 4 45 4 175
5 185 5 100 5 25
NPV = -130 NPV = 15 NPV = 12
NPV of Project B is the highest.
Project A Project B Project C
Cash Flow Years Cash Flow Cash Flow Years Cash Flow Cash Flow Years Cash Flow
0 -500 0 -250 0 -400
1 45 1 85 1 175
2 55 2 65 2 75
3 65 3 55 3 75
4 175 4 45 4 175
5 185 5 100 5 25
IRR = 1.31% IRR = 12.36% IRR = 11.40%
Profitability Index = PV of Future Cash Flows/Initial Investment
Project A 0.74 Project B 1.06 Project C 1.03
Payback period is defined as the expected number of years required to recover the original investment.
Project A
Period 0 1 2 3 4 5
Net cash flow -500 45 55 65 175 185
Cumulative NCF -500 -455 -400 -335 -160 25 ...
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