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Capital Budgeting

VIEWS: 87 PAGES: 19

									NPV Analysis of Mutually Indepen
Years of Return of Projects (up to 20 years) MARR (Minimum Acceptable Rate of Return) Interest Rate 8

Option 5

Option 4

10 10

% %
-200

Option 3 Option 2 Option 1
-100 0

Investment Options (order the options in the increasing order of Initial Investments
Option Number 0 1 2 3 4 5 Explanation Do Nothing Purchase Machine A Purchase Machine B Purchase Machine A&B Purchase Machine C Purchase Machine A&C Initial Investments 0 1000 1200 2000 2500 3300 Annual Return 0 250 330 500 600 900 Annual Disbursement 0 50 60 110 150 200

NPV Analysis of the Projects

The best option is Option 5 with the largest Net Present Value

Option 1
Year
0 1 2 3 4 5 6 7 8 8

Option 2
Cum. Cash Flow
-1,000 -818 -653 -503 -366 -242 -129 -26 67 160

Option 3
Cum. Cash Flow
-1,200 -955 -731 -529 -344 -176 -24 114 240 343

PV Factor
100% 91% 83% 75% 68% 62% 56% 51% 47% 47%

Net Cash PV of Cash Flow Flow
-1,000 200 200 200 200 200 200 200 200 200 -1,000 182 165 150 137 124 113 103 93 93

Net Cash PV of Cash Flow Flow
-1,200 270 270 270 270 270 270 270 270 220 -1,200 245 223 203 184 168 152 139 126 103

Net Cash Flow
-2,000 390 390 390 390 390 390 390 390 420

of Mutually Independent Projects

NPV

100

200

300

400

500

600

ents
Annual Net Cash Scrap Value at Flow the end 0 0 200 200 270 220 390 420 450 0 700 200 NPV of the Projects 0 160 343 277 -99 528

The option can be taken The option can be taken The option can be taken This option should not be taken. The option can be taken

Option 3
PV of Cash Flow
-2,000 355 322 293 266 242 220 200 182 196

Option 4
Cum. Cash Flow
-2,000 -1,645 -1,323 -1,030 -764 -522 -301 -101 81 277

Option 5
Cum. Cash Flow
-2,500 -2,091 -1,719 -1,381 -1,074 -794 -540 -309 -99 -99

Net Cash PV of Cash Flow Flow
-2,500 450 450 450 450 450 450 450 450 0 -2,500 409 372 338 307 279 254 231 210 0

Net Cash PV of Cash Flow Flow
-3,300 700 700 700 700 700 700 700 700 200 -3,300 636 579 526 478 435 395 359 327 93

Cum. Cash Flow
-3,300 -2,664 -2,085 -1,559 -1,081 -646 -251 108 434 528

a 1 2 3 IRR 10 5 C NPV 160 343 277 -99 528 528 0 160 343 277 -99 528 Do Nothing Option 1 Option 2 Option 3 Option 4 Option 5 Option 5 TRUE TRUE TRUE FALSE TRUE 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Option 1 Option 2 Option 3 Option 4 Option 5

Calculatıons and Cha number first second third fourth fifth 4 1 2 3 5 10 a <10 a >2 a >5

a >1 a >3

0.137044742 0.167390279 0.131513594 TRUE 1 14% TRUE TRUE TRUE TRUE TRUE 2 17%

0 0.140766703 0.313098215 0.125999743 0 1 2 3 TRUE FALSE TRUE TRUE TRUE FALSE 3 4 5 1and2 1and3 1and4 13% 9% 14% 31% 13% 5% TRUE FALSE TRUE TRUE TRUE FALSE TRUE TRUE TRUE TRUE TRUE TRUE

1and2 -1,000 200 200 200 200 200 200 200 200 200 0 0 0 0 0 0 0 0 0 0 0 -1,200 270 270 270 270 270 270 270 270 220 0 0 0 0 0 0 0 0 0 0 0 -2,000 390 390 390 390 390 390 390 390 420 0 0 0 0 0 0 0 0 0 0 0 -2,500 450 450 450 450 450 450 450 450 0 0 0 0 0 0 0 0 0 0 0 0 -3,300 700 700 700 700 700 700 700 700 200 0 0 0 0 0 0 0 0 0 0 0 -200 70 70 70 70 70 70 70 70 20 0 0 0 0 0 0 0 0 0 0 0

1and3 -1,000 190 190 190 190 190 190 190 190 220 0 0 0 0 0 0 0 0 0 0 0

1and4 -1,500 250 250 250 250 250 250 250 250 -200 0 0 0 0 0 0 0 0 0 0 0

Calculatıons and Chart Data

0.1425141 0 0 0 0.123941372 0 0 0 0.157106859 0 4 5 6 7 8 9 10 11 12 13 TRUE FALSE FALSE TRUE FALSE TRUE 1and5 2and3 2and4 2and5 3and4 3and5 14% #DIV/0! -2% 12% #DIV/0! 16% TRUE FALSE TRUE FALSE TRUE FALSE FALSE FALSE TRUE FALSE TRUE FALSE FALSE TRUE TRUE FALSE FALSE FALSE TRUE FALSE

1and5 -2,300 500 500 500 500 500 500 500 500 0 0 0 0 0 0 0 0 0 0 0 0

2and3 0 -25 -47 -67 -86 -102 -118 -131 -144 -117 0 0 0 0 0 0 0 0 0 0 0

2and4 2and5 -1,300 -2,100 180 430 180 430 180 430 180 430 180 430 180 430 180 430 180 430 -220 -20 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

3and4 3and5 -500 -1,300 60 310 60 310 60 310 60 310 60 310 60 310 60 310 60 310 -420 -220 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

TRUE TRUE 0 14 0 16 FALSE 4and5 28% FALSE FALSE FALSE TRUE 0 15 IRR first best best&second best&third best&fourth best&fifth 13.70% 31.31% 0.00% 12.39% -10000.00% current best 1 2 2 5 5 Inc.IRR 13.70% 31.31% 0.00% 12.39% MARR 10.00% 10.00% 10.00% 10.00% 10.00%

FALSE FALSE

4and5 -800 250 250 250 250 250 250 250 250 200 0 0 0 0 0 0 0 0 0 0 0

1 2 3 4 5

Opt1 Opt(2-1) Opt(3-2) Opt(5-2)

TRUE TRUE TRUE TRUE TRUE

TRUE TRUE TRUE TRUE TRUE TRUE

0 1 2 3 4 5 6 7 8 9 10

FALSE FALSE FALSE FALSE FALSE FALSE FALSE FALSE FALSE TRUE FALSE

11 12 13 14 15 16 17 18 19 20

FALSE FALSE FALSE FALSE FALSE FALSE FALSE FALSE FALSE FALSE

IRR Analysis of Mutually Independent Projec
Options with negative NPV are eliminated from Incremental IRR Analysis. Also options with IRR smaller than MARR are eliminated. Minimum Acceptable Rate of Return: 10.00%
35.00%
30.00%

Options to be investigated and their Internal Rates of Returns: Options 1 Purchase Machine A 2 Purchase Machine B 3 Purchase Machine A&B 5 Purchase Machine A&C IRR 13.70% 16.74% 13.15% 14.08%

25.00%
20.00%

15.00%
10.00%

Incremental IRR Calculations: Inc. IRR Current Best Opt1 13.70% Opt1 Opt(2-1) 31.31% Opt2 Opt(3-2) 0.00% Opt2 Opt(5-2) 12.39% Opt5

5.00%
0.00%

Incremental IRR Analysis of the Projects

Option 5 is the best option for the investment in Incremental IRR Analysis

ndependent Projects

Inc.IRR
MARR

Opt1

Opt(2-1)

Opt(3-2)

Opt(5-2)

0 1 2 3 4 5

INCREMENTAL IRR ANALYSIS
0 A = Current Best Option B = Challenger Option Elminate options with negative NPV and with IRR<MARR Let N = number of remaining options

1 Set A =1, B = 2

2 B ?=? N+1 █ yes █ A is the best option. end ▬▬ no

TAL IRR ANALYSIS

3 ▬▬ IRR of (B - A) █ >=MARR █ A = B and B = B+1 return to 2 ▬▬ <MARR ▬▬ B = B+1 return to 2

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