A company, from time to time, will have to make investments in a variety of capital projects. Whether it is the need to purchase new machinery, expanding the production facility, or even buying new transport, all these projects require firms to make high investment now. In all these projects, the cash flow or the benefit […]

# Capital Budgeting

## Principles of Capital Budgeting

Even though the capital budgeting decisions can be very complex with lots of underlying assumptions and variations, most decisions have the following basic principles underlying them. 1. Decisions are based on cash flow not accounting income The capital budgeting decisions are based on the cash flow forecasts instead of relying on the accounting income. These […]

## Mutually Exclusive Projects, Project Sequencing, and Capital Rationing

The cash flow analysis for making capital decisions can become more complex because of the interaction between different projects. The finance manager will have to work with these complexities while evaluating and selecting projects Independent Vs. Mutually Exclusive Projects The projects being analyzed by a company may be completely independent of each other or mutually […]

## Net Present Value of a Project

This video explains the concept of net present value (NPV) and shows how it is calculated.

## Calculating Net Present Value (NPV) and Internal Rate of Return (IRR) in Excel

Net Present Value (NPV) Function The NPV function calculates the present value of a series of cash flows at equal time intervals. The function is represented as follows: = NPV(rate,value1,value2,…) Here, rate is the discount rate for one period, and values are the cash flows. Any payments are entered with a negative sign, and income […]

## How to Calculate Payback Period

The payback period of a project is defined as the number of years it takes for the project to recover its original investment. Let’s take a simple example to understand how payback period is calculated. Assume that a company invests $5,000 in a project, which generates the following cash flow in the next 5 years. […]

## How to Calculate Discounted Payback Period

We learned that one of the drawbacks of payback period is that it does not consider time value of money. An alternative is to use the discounted payback period. The discounted payback period is the number of years it takes to recover the initial investment in terms of the present value of the cash flows. […]

## Calculating Profitability Index of a Project

The profitability index, also known as the profit investment ratio, is calculated as the ratio of the present value of the future cash flows and the initial investment in the project. Since NPV is the difference between the present value of future cash flows and initial investment, the profitability index can also be expressed in […]

## Conflict Between NPV and IRR

When you are analyzing a single conventional project, both NPV and IRR will provide you the same indicator about whether to accept the project or not. However, when comparing two projects, the NPV and IRR may provide conflicting results. It may be so that one project has higher NPV while the other has a higher […]