One Response for "Please help with capital budgeting…How do I do this?"

1. isis January 25th, 2010 at 11:06 pm 1

   Year Cash flow
   0 – $500,000: cash outflow
   1 85,000: cash inflow
   2 150,000: cash inflow
   3 +$700,000: cash inflow

   ·If the discount rate is 0%, what is the project’s net present value?

   as the discount rate is 0% the value of the money has not changeg so the net present value of the project will be the sum of all the inflows minus the sum of all outflows:

   NPV= -500000 +85000+ 150000+ 700000= 435000

   ·If the discount rate is 5%, what is the project’s net present value?

   we apply this formula:
   NPV= FV (1-dn)
   NPV: net present value
   FV: future value
   d: discount rate
   n: number of years

   NPV= -500000+ 85000(1-0.05×1)+ 150000(1-0.05×2)+ 700000(1-0.05×3)=310750

   ·What is this project’s internal rate of return?

   500000= [85000/(1+IRR)^1]+ [150000/(1+IRR)^2]+ [85000/(1+IRR)^3]

   as you can see this is very difficult to solve, but it can be solved using excel, but I don’t Know how, so I use a method of Schneider which gives an aproximation to the calculation written above:

   IRR= (-500000+ 85000+ 150000+ 700000) / (85000×1+ 150000×2+ 700000×3)= 0.175050301
   aproximately 17.5% of internal rate of return