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## Capital budgeting techniques

- The NPV method is used for evaluating the desirability of investments or projects.
- The discount factor r can be calculated using:
- Decision rule: If NPV is positive (+): accept the project, If NPV is negative (-): reject the project
- The IRR is the discount rate at which the NPV for a project equals zero. This rate means that the present value of the cash inflows for the project would equal the present value of its outflows. The IRR is the break-even discount rate. The IRR is found by trial and error.
- Small businesses use this method because it is simple. It requires calculation of number of years required to pay back original investment
- Between two mutually exclusive investment projects, choose project with shortest payback period
- Set a predetermined standard
- Ex. “Accept all projects with payback of less than 5 years and reject all others”
Net present value (NPV) Where:
Ct = the net cash receipt at the end of year t
Io = the initial investment outlay r = the discount rate/the required minimum rate of return on investment n = the project/investment's duration in years. Where,
r = IRR IRR of an annuity Where, PaybackQ (n,r) is the discount factor, I _{o} is the initial outlay, C is the uniform annual receipt (C1 = C2 =....= Cn). |

Last modified: Saturday, 23 June 2012, 7:44 AM