Capital Budgeting Techniques
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Strategic decision makers are required to be able to evaluate projects based on the long-term objectives of the firm as well as the project’s ability to earn the company additional compensation. The 3 main tools used to make this evaluation are the pay-back period, net present value (NPV), and internal rate of return (IRR).
|
Year |
Project #1 |
Project #2 |
Project #3 |
|
0 |
($30,000) |
($32,000) |
($35,000) |
|
1 |
$11,000 |
$15,000 |
$11,000 |
|
2 |
$11,000 |
$14,000 |
$11,000 |
|
3 |
$11,000 |
$11,000 |
$11,000 |
|
4 |
$11,000 |
$2,000 |
$11,000 |
|
5 |
$11,000 |
$500 |
$11,000 |
|
Scenario |
NPV Rate |
|
1 |
5% |
|
2 |
5.5% |
|
3 |
6% |
Using the data in the tables above, answer the following questions:
- Calculate the NPV for each project using each scenario’s NPV rate. Show your work.
- Calculate the pay-back period for each project. Show your work.
- Calculate the IRR for each project. Show your work.
- Which project would the company select using the NPV method in scenario 1? Explain your answer.
- Which project would the company select using the NPV method in scenario 2? Explain your answer.
- Which project would the company select using the NPV method in scenario 3? Explain your answer.
- Which project would the company select using the pay-back period? Explain your answer.
- Which project would the company select using the IRR method? Explain your answer.
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