Capital Budgeting Subtopics PDF

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Subtopics and sample exercises of Capital Budgeting...

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CAPITAL BUDGETING SUBTOPICS I. INVESTMENT DECISIONS A. Independent Projects Techniques NPV IRR PI PAYBACK ARR

ACCEPT + Greater than DR Greater than 1 Less than ½ life Greater than DR

REJECT Less than DR Less than 1 Greater than ½ of life Greater than DR

INDIFFRENT 0 = DR =1 = ½ of life = DR

B. Mutually Exclusive Projects  Basis is PROFITABILITY INDEX Comprehensive Exercise:

1. Should the company accept or reject each of the projects on the basis of the following techniques: a. NET PRESENT VALUE Project ABC – at discount rate Cash Flows after tax (P200,000 x 3.1699) 633,980 LESS: Net Investment (600,000) NPV 33,980

b. Project ABC – at INTERNAL RATE OF RETURN (workback and trial and error) Cash flow after-tax (P200,000 x 3.00) *600,000 Net Investment (600,000) NPV P0.00 IRR (excel)

YouTube sample (PROJECT ABC) NI IRR

12.59%

CFAT Y0 Y1 Y2 Y3 y4 - ₱600,000.00 ₱200,000.00 ₱200,000.00 ₱200,000.00 12.59%

c. Profitability Index (Project ABC) Solution: (33,980 / 600,000) + 1

1.06

d. Payback Period ni project ABC (even CFAT) – note: if there is only one cash inflow which is CFAT (no salvage value & work cap) and the CFAT must be even. The payback period is the present value factor of IRR. Solution: (600,000 / 200,000) 3 years e. ARR – silent so base sa average investment (use net income not CFAT) Solution: CFAT 200,000 Depreciation Expense (600,000 / 4 years) (150,000) Net Income 50,000 Average Investment (use NI) = (600,000 + 0) / 2 ARR = 50,000 / 300,000 ARR = 16.67% PROJECT ABC INVESTMENT DECISIONS TECHNIQUE DECISION NPV - 33,980 ACCEPT IRR - 12.59% ACCEPT PI - 1.06 ACCEPT PAYBACK - 3 years REJECT! – mas mahaba sa cut-off (1/2 of life) ARR - 16.67% ACCEPT OVERALL DECISION ACCEPT PROJECT ABC

PROJECT XYZ – uneven cash flow

₱200,000.00

a. NPV at Discount Rate (use PV of 1 because uneven cash flows) Y1 (250,000 x 0.9091) 227,275 Y2 (300,000 x 0.8264) 247,920 Y3 (200,000 x 0.7513) 150,260 Y4 (200,000 x 0.6830) 136,600 Less: Net investment (800,000) NET PRESENT VALUE (37,945)

b. Internal Rate of Return IRR = 7.67% c. Profitability Index PI = (-37,945 / 800,000) + 1 PI = 0.95 d. Payback Period PP = (3 years + (50,000 / 200,000)) PP = 3.25 years e. Book Rate of Return / ARR (since problem is silent use average investment) – uneven *Average CFAT 237,500* Depreciation Expense (800,000 / 4 years) (200,000) Net income 37,500 *Average CFAT (uneven CFAT) = (250k + 300k + 200K + 200K) / 4 Average CFAT = 237,500 * Average Investment = 800,000 + 0 / 2 = 400,000 ARR = 37,500 / 400,000* ARR = 9.38% PROJECT XYZ INVESTMENT DECISIONS TECHNIQUES DECISION NPV - (37,945) REJECT IRR - 7.67% REJECT PI - 0.95 REJECT PAYBACK - 3.25 years REJECT ARR - 9.38% REJECT OVERALL DECISION REJECT 2. If the projects are mutually exclusive, the company should accept PROJECT ABC only.

Compare profitability index: PI – PROJECT ABC PI – PROJECT XYZ

II.  



1.06 0.95

ACCEPT PROJECT (higher PI) REJECT PROJECT

CAPITAL RATIONING – prioritization decision Applies for INDEPENDENT projects (not MPE) There is a budget constraint – since pag IP you can accept all projects pero may budget constraint so, you need to choose a combination of projects to be accepted so that we can maximize our resources as well as maximize the overall net present value. Maximizing the resources as well as the overall NPV (goal of capital rationing) – specifically budget constraint

STEPS IN CAPITAL RATIONING 1) RANK the projects according to their PROFITABILITY INDEX 2) CHOOSE the combination of projects with the highest combined NET PRESENT VALUE

SOLUTION: (RANK) PROJECTS 1st C 2nd B 3rd A

PROFITABILITY INDEX 1.14 1.13 1.02

COST 380,000 470,000 400,000

NET PRESENT VALUE 54, 666 59, 654 7,540

Choose the combination of projects that will result with the highest combined NPV Answer: CHOOSE C & B with a combined NPV of P114,320. DISCUSION EXERCISES: MCQ 1) Capital Budgeting

C. is the process of making capital expenditure decisions 2) S1: Capital Expenditure proposals are initially screened by the stockholders. S2: The capital budget for the year is approved by a company’s capital budgeting committee since they are part of the board of directors. D Both statements are false 3) Performing Post-Audit Evaluation is important because

A. I and II 4)

D. II and III...