# Capital Budgeting Techniques

Colorado Texas New Line Replace Acquire Pollute Cumulative NPV

0 $(1,319,000) $(3,534,000) $(1,582,000) $(4,845,000) $(24,050,000) $(1,650,000)

1 $(233,318) $(583,296) $465,263 $661,105 $4,374,354 $-

2 $525,358 $1,260,859 $766,303 $831,781 $3,146,041 $-

3 $480,408 $1,104,938 $725,619 $710,338 $3,208,962 $2,000,000

4 $443,211 $975,064 $696,446 $628,331 $3,273,141

5 $410,525 $862,103 $383,065 $574,938 $3,338,604

6 $393,172 $786,450 $197,318 $591,281 $3,405,376

7 $372,189 $744,379 $192,677 $608,404 $3,473,484

8 $323,470 $646,834 $158,739 $539,522 $3,542,953

9 $270,306 $486,552 $123,951 $472,081 $3,613,812

10 $235,748 $2,872,825 $279,133 $551,449 $41,652,800

IRR 18.28% 16.69% 30.84% 5.01% 17.24% 6.62%

MIRR 13.65% 13.41% 16.29% 7.69% 14.61% 6.62%

MIN IRR 10% 10% 13% 8% 13% 8%

Payback 2.44 2.59 2.52 1.27 3.04

NPV $2,104,956 $4,939,824 $2,494,182 $3,072,136 $14,217,224 $26,828,321

Using the data from the attached mini case study and financial spreadsheets attached I need to conduct a profitability index. All work on this index should be included in a detailed excel spreadsheet.

Also using the information from the profitability index please provide recommendations on which capital budgeting projects should be selected and give me reasons based on the profitability index.

Please provide as much information as possible.

© BrainMass Inc. brainmass.com April 3, 2020, 2:52 pm ad1c9bdddfhttps://brainmass.com/business/capital-budgeting/capital-budgeting-techniques-48633

#### Solution Preview

Profitability Index

What does it Mean?

Profitability index is the ratio of the present value of cash inflows, at the required rate of return, to the initial cash outflow of the investment.

An index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio calculated as:

A ratio of 1.0 is logically the lowest acceptable measure on the index. Any value lower than 1.0 would indicate that the project's NPV is less then the initial investment. As values on the profitability index increase, so does the financial attractiveness of the proposed project. This concept is based on Time value of Money.

What Is Time Value?

If you're like most people, you would choose to receive the $10,000 now. After all, three years is a long time to wait. Why would any rational person defer payment into the future when he or she could have the same amount of money now? For most of us, taking the money in the present is just plain instinctive. So at the most basic level, the time value of money demonstrates that, all things being equal, it is better to have money now rather than later.

But why is this? A $100 bill has the same value as a $100 bill one year from now, doesn't it? Actually, although the bill is the same, you can do much more with the money if you have it now: over time you can earn more interest on your money.

Present Value Basics

If you received $10,000 today, the present value would of course be $10,000 because present value is what your investment gives you now if you were to spend it today. If $10,000 were to be received in a year, the present value of the amount would not be $10,000 because you do not have it in your hand now, in the present. To find the present value of the $10,000 you will receive in the future, you need to pretend that the $10,000 is the total future value of an amount that you invested today. In other words, to find the present value of the future $10,000, we need to find out how much we would have to invest today in order to receive that $10,000 in the future.

The following are the PI acceptance rules:

Accept the project when PI is greater than one. PI > 1

Reject the project when PI is less than one. PI < 1

May accept the project when PI is equal to one. PI = 1

The project with positive NPV will have PI greater than one. PI less than means that the project's NPV is negative.

2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why?

Several different procedures are available to analyze potential business investments. Some concepts are better than others when it comes to reliability but all ...

#### Solution Summary

This illustrates the step by step explanation of various capital budgeting techniques with the help of mini case study.