Capital Budgeting Clarification Example

By computing the highest discount rate at which a project will have a positive NPV, the IRR method is supposed to assure that the actual rate of return on an accepted project is higher than the required rate of return.

Internal Rate of Return is a discount rate in which the net present value of an investment becomes zero. The investment should be accepted if the IRR is not less than the cost of capital. The IRR measures risk, by showing what the discounted rate would have to reach to lose all present value. Futronics Inc. investment would have an IRR of 14.79%. The investment should be accepted since it is greater than the 8% cost of capital. The 14.79% IRR shows the growth expected from the

32) Compute the NPV for the following project. The initial cost is $5,000. The net cash flows are $1,900 for four years. The net salvage value is $1,000 when the project terminates. The cost of capital is 10%.

Capital Budgeting encourages managers to accurately manage and control their capital expenditure. By providing powerful reporting and analysis, managers can take control of their budgets.

ii. The project should be accepted if the NPV is positive because such a project increases shareholder value.

Capital budgeting decisions involve investments requiring large cash outlays at the beginning of the life of the project and commit the firm to a particular course of action over a relatively long period of time. As such, they are costly and difficult to reverse, both because of: (1) their large cost and (2) the fact that they involve fixed assets, which cannot be liquidated easily.

IRR is the rate at which the net present value becomes zero (Ross, Westerfield & Jordan, 2013). Additionally, IRR is calculated first by determining the Net Present Value. The Net Present Value is the variance concerning the market value and its cost (Ross, Westerfield & Jordan, 2013). Net present value is calculated by first finding the present value. For instance, 21.83 million (year 1 revenue from above) divided by 1 plus the companies rate of return of 12%. Thus, 21.83/(1+.12)= 19.49 is the present value for year 1. Furthermore, by adding the total revenue over the next 5 years we get 21.85+ 28.025+36.875+30.975+23.6=132.325 million is the expected value of revenue. That amount now needs to be placed into the present value equation previously discussed only this time with the exponent of 5 to cover the next 5 years. 132.325/(1+.12)^5=75.08 (rounded). Moreover, if

1. What is the appropriate required rate of return against which to evaluate the prospective IRR 's from the B ANSWER:The appropriate rate of return against which to evaluate the IRR is the risk-free rate, plus the market risk

3. The NPV method is better because it shows the size of the project so you can see how much value a project has not just a percentage. You could have a higher percentage but a much lower value and you would still go for the lower percentage.

All components of the budgeting process hinge on each other and must be carefully coordinated by the district to prevent wasted time and money at the taxpayer’s expense. Capital budgeting is important for developing strategic goals, facilitating communication, and justifying decisions (https://www.schooldude.com/content/capital-budgeting-importance).

Expected value of IRR = IRR1 * probability 1 + IRR2 * probability 2 + IRR3 * probability 3

When using NPV to determine whether or not to invest in a project, the general rule is to accept the project if NPV > 0 and reject if NPV is negative (or zero). The NPV for the proposed NBC contract is, as seen in table 4 is £137,350.26. On this basis NPV the contract does appear a positive investment. To investigate this further the internal rate of return is calculated below.

To find the internal rate of return, one needs to find the values of r that satisfies the following equation:YearCash Flow0-1001+302+353+404+45Internal Rate of Return (IRR)IRR = r,IRR = 17.09%Net Present Value (NPV)Thus using r = IRR = 17.09%,If the NPV is close to zero then r is the IRR.

In todays economic climate every company or organization is looking for a way to get ahead of its competition. Every owner, CEO, or president is looking for away to keep his or her company or organization on solid financial ground. The one thing that they realize is, in order for a company or organization to stay solvent they will need to find away to stay competitive in their perspective markets. They have found that this may be done by some type of investment(s), in the form of acquisition, and or merger. In the world of business, capital budgeting is one of the most important steps that a company or organization can take. This process is called Capital budgeting. Capital budgeting is a process that attempts to determine the future.

Internal rate of return (IRR) is the discount rate that makes NPV equal to zero. It is also called the time-adjusted rate of return.