Formulas:

Payback Period:
Original Investment
Annual cash Inflows

Accounting Rate of Return

Average Net Incom
Initial Investment

Net Present Value

Present Value of Inflows - Present Value of Outflows

Internal Rate of Return

Initial Investment
Cash Flows
Ra+(NPVa/(NPVa-NPVb))*(Rb-Ra)

Profitability Index
PV of all Cash Flows
Initial Investment
1+NPV/Initial Investment
NPV+Initial Investment
Initial Investment

Case 1 - Family Discussion

Project A (Car)
Incremental Cash Flows
Change in Revenue
Change in Costs
Net change before income taxes
Net increase in taxes
Incremental Cash Flow

36,500.00
(12,800.00)
23,700.00
(4,740.00)
18,960.00

Terminal Cash Flow

Incremental Net Cash Flow
Salvage Value
Taxes from asset sale

Project B (Laundry Shop)

Incremental Cash Inflows
Year
1
30000.00
2
35000.00
3
40000.00
4
55000.00
5
60000.00

18,960.00
150,000.00
(30,000.00)
138,960.00

Calculating Payback:
Project A

Project B

Beggining
Balance

Year
0
1
2
3

-120000.00
-120000.00
-101040.00
-82080.00

Net Cash Flows

0.00
18960.00
18960.00
138960.00

Ending
Balance
-120000.00
-101040.00
-82080.00
56880.00

Year
0
1
2
3
4
5

Beggining
Balance
-120000.00
-120000.00
-90000.00
-55000.00
-15000.00
40000.00

176,880.00

Payback Period =

2.59

Years

Given that the project will give a reasonable service for

3 years, this investment achieved payback soon
enough. Therefore, the payback criteria indicate that
this investment should be accepted.

Payback Period =

Given that the project will give a reaso

for 5 years, this investment achieved
enough. Therefore, the payback criteria
this investment should be acce

Conclusion:

The payback period for Project A is 2.59 years. The payback period for Project B is 3.27
projects are acceptable because their payback periods are less than their maximum pay
criterion of 3 years and 5 years, respectively. However, Project B has a shorter payback pe
provides higher return. Therefore, the family should go for project B.

Calculating Accounting Rate of Return:

Project A

Project B
ARR =

0.4913

ARR =

Conclusion:

The accounting rate of return of Project A is 49.13%. The accounting rate of return for
37.67%. If only accounting rate of return is considered, the project A is the best proposa
expected accounting rate of return is the higher. Therefore, under this standard, the fam
choose Project A.

Net Cash Flows

0.00
30000.00
35000.00
40000.00
55000.00
60000.00
220,000.00

3.27

Ending
Balance
-120000.00
-90000.00
-55000.00
-15000.00
40000.00
100000.00

Years

e project will give a reasonable service

his investment achieved payback soon
fore, the payback criteria indicate that
vestment should be accepted.

riod for Project B is 3.27 years. Both

than their maximum payback period
has a shorter payback period and also
ould go for project B.

0.3667

unting rate of return for Project B is

ect A is the best proposal because its
der this standard, the family should

Calculating Internal Rate of Return:

Project A
Year
0
1
2
3
NPV
IRR =

PV of Cash
PV of Cash
PV of Cash
Cash Flows
Flows at 10% Flows at 15% Flows at 16%
-120000.00
(120,000.00)
(120,000.00)
(120,000.00)
18960.00
16,495.20
16,343.52
17,234.64
18960.00
14,333.76
14,087.28
15,660.96
138960.00
91,435.68
89,073.36
104,358.96
17,254.56
2,264.64
(495.84)
0.1582

Project B
Year
0
1
2
3
4
5
NPV
IRR =

PV of Cash
PV of Cash
PV of Cash
Cash Flows
Flows at 15% Flows at 20% Flows at 21%
-120000.00
(120,000.00)
(120,000.00)
(120,000.00)
30000.00
26,010.00
24,990.00
24,780.00
35000.00
26,460.00
24,290.00
23,905.00
40000.00
26,320.00
23,160.00
22,560.00
55000.00
31,460.00
26,510.00
25,685.00
60000.00
29,820.00
24,120.00
23,160.00
20,070.00
3,070.00
90.00
0.2103

Conclusion:

Project A has an internal rate of return of 15.82%. Project B has an internal rate of
return of 21.03%. Both are lower than their discount rates of 49.13% and 36.67%,
respectively, hence, they should be rejected. However, if we have to choose
between the two, Project B's larger IRR can be taken as a signal that B provides a
better rate of return than A. Other things being equal, and using the IRR as the
decision criterion, the project with the higher IRR (B) is considered the better
choice. Therefore, the family should go for Project B if they intend to choose one
alternative over the other despite of its effects.

PV of Cash
Flows at 17%
(120,000.00)
16,210.80
13,859.76
86,711.04
(3,218.40)

PV of Cash
Flows at 22%
(120,000.00)
24,600.00
23,520.00
22,040.00
24,805.00
22,200.00
(2,835.00)

B has an internal rate of

s of 49.13% and 36.67%,
we have to choose
signal that B provides a
d using the IRR as the
nsidered the better
y intend to choose one

Calculating Net Present Value:

Project A
Year

Project B
Cash Flows
PV factor
0 (120,000.00)
1.00
1
18,960.00
0.67
2
18,960.00
0.45
3
138,960.00
0.30

NPV

PV of Cash
Flow
(120,000.00)
12,722.16
8,532.00
41,965.92

(56,779.92)

Year
1.00
2.00
3.00
4.00
5.00

Cash Flows
(120,000.00)
30,000.00
35,000.00
40,000.00
55,000.00
60,000.00

NPV

Conclusion:

Project A has a net present value of -56779.92. Project B has a net present value of -352
projects have NPVs which are lesser than zero or in other words, negative and, hence, sh
be rejected. However, in comparison between the two projects, then the project with th
NPV (Project B) is more desirable. Therefore, with regards to the NPV criterion, none sho
undertaken. If the family insists on undertaking one alternative, then they should go for

Calculating Profitability Index:

Project A

Project B
PI =

0.5268

PI =

Conclusion:

The profitability index of Project A is 52.68%. The profitability index of Project B is 70.63
the projects PI is less than 1, which is due to their negative NPVs, and hence, should bot
rejected. However, if the family had to choose one among the two projects, then the pro
the higher PI (Project B) is more favorable. Therefore, according to the PI criterion, both
should not be undertaken. If the family insists on undertaking one project, then they sho
Project B.

PV factor
1.00
0.73
0.54
0.39
0.29
0.21

PV of Cash
Flow
(120,000.00)
21,960.00
18,725.00
15,680.00
15,785.00
12,600.00
(35,250.00)

et present value of -35250. Both

negative and, hence, should both
then the project with the higher
NPV criterion, none should be
then they should go for project B.

0.7063

ex of Project B is 70.63%. Both of

, and hence, should both be
o projects, then the project with
o the PI criterion, both projects
e project, then they should go for

Overall Conclusion:

Both projects have Payback Periods well within their respective time
periods of 3 and 5 years, respectively. Project B has the shortest Payback
Period of 3.27 years and Project A is only slightly longer (about 4.32 years
if we assume a common useful life of 5 years).
The Net Present Value of Project B is -35250.00 compared to only
-56779.92 for Project A. Both are undesirable and should be rejected.
However, if the family insists on choosing one investment project, Project B
is the preferred investment because its NPV is higher. Also, Project B
provides more return per peso of investment as shown with the Profitability
Index (0.7063 for Project B versus 0.5268 for Poject A).
Both projects have low Internal Rate of Returns in comaparison with their
discount rates (their ARR). This indicates that both projects are unprofitable
and should both be rejected. However, Project B has a higher IRR
compared to Project A. If one capital project should be accepted, its
Project B.
In my opinion, the family should undertake neither of the projects. But if
they insist on choosing one, between the Car (Project A) and the Laundry
Shop (Project B), then based on the results of the different capital
budgeting tehniques applied thus far, I would say that Project B should be
chosen for the results say that it is more favorable.

Case 2 - Secretary or Gorilla

Alternative 1- retain the secretary
9,600 annual salary

Alternative 2- buy the gorilla

8,000 cost of gorilla
2,000 annual supply of banana
2,400 annual care and maintenance
500 salvage value

12% rate of return

35% tax bracket
Payback Period
8,000
3,380
2.3668639

2.37x365 days
28.835
2 years and 4 months

Discounted Payback Period

Year

Cash Flows
PV factors Discounted Cash Flows
0
(8,000.00)
1
-8,000
1
3,380.00
0.893 3,018.34
-4,982
2
3,380.00
0.797 2,693.86
-2,288
3
3,380.00
0.712 2,406.56
4
3,380.00
0.636 2,149.68
5
3,880.00
0.567 2,199.96
9,400.00
4,468

Year

Cash Flows
PV factors Discounted Cash Flows
0
-8000.00
1
-8,000
1
3,380.00
0.893 3,018.34
2
3,380.00
0.797 2,693.86
3
3,380.00
0.712 2,406.56
4
3,380.00
0.636 2,149.68
5
3,880.00
0.567 2,199.96
9,400.00
4,468

2.85x365 days
34.675
2 years and 10 months

Net Present Value

Profitability Index

Internal Rate of Return

Rate
Year 0
Year 1
Year 2
Year3
Year 4
Year 5

12,468
8,000
1.55855

12%
-8000
3,380
3380
3380
3380
3880

0.893
0.797
0.712
0.636
0.567

30%
-8000
3018.34
2693.86
2406.56
2149.68
2199.96

0.769
0.592
0.455
0.35
0.269

-8000
2599.22
2000.96
1537.9
1183
1043.72

Case 2 - Secretary or Gorilla

NPV

4,468

364.8

IRR= Ra + [NPVa/(NPVa-NPVb)] x (Rb-Ra)

= 30+[364.8/(364.8+384.9)]*(35-30)
IRR=32.43%

Decision:

The purchase of the gorilla should be pushed through since it will still yield good returns
to the company. As the salary of the secretary will be saved, it will be much beneficial to
the company since the annual expenses pertaining to the care and maintenance of the
gorilla is just minimal. The savings brought about by such alternative is high enough to
recover the original investment within a period of 2 years and 10 months, using the
discounted payback, or for a period of 2 years and 4 months notwithstanding the present
value of the inflows. This is good for the company as the payback period is way much
shorter than the gorilla's useful life, and that having a shorter time to recover all the
original investments ensures safety of the investment. Also, with the said investment in
the gorilla, its returns is almost thrice the company's rate of return, which means that it is
profitable. And as it yields a positive net present value based on the company's current
hurdle rate, the proposed replacement of the secretary by a gorilla should be accepted.

Case 2 - Secretary or Gorilla

maintenance

ash Flows
1.00
1.85

2.85

ash Flows

35%
0.741
0.549
0.406
0.301
0.223

-8000
2504.58
1855.62
1372.28
1017.38
865.24

Case 2 - Secretary or Gorilla

-384.9

Case 3 - Nathnina Company

Computation of Tax Paid (Savings) on Sale of Old Building

Cost:
Residual Value:
Current Market Value:
Life:
Remaining Useful Life:
Type of Depreciation:
Tax Rate:

Salvage Value, before tax:

Cost, After Salvage Value:
Sum Of The Year's Digits
(SYD):

Year
1
2
3
4
5
6
7
8
9
10
Accumulated Depreciation
Current Market Value:
Less:Book Value
Gain on Sale of Old Building
Tax Rate:
Tax Paid on Sale of Old Building

1,500,000.00
300,000.00 (after tax)
1,000,000.00
15 years
5 years
Sum of Year's Digit
40%

500,000.00
1,000,000.00
15[(15+1)/2]=120

SYD
15/120
14/120
13/120
12/120
11/120
10/120
9/120
8/120
7/120
6/120

Percentage
0.125
0.117
0.108
0.100
0.092
0.083
0.075
0.067
0.058
0.050

1,000,000.00
625,000.00
375,000.00
0.40
150,000.00

Case 3 - Nathnina Company

Cost, After Salvage Value Depreciation

1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00
1,000,000.00

125,000.00
116,666.67
108,333.33
100,000.00
91,666.67
83,333.33
75,000.00
66,666.67
58,333.33
50,000.00

875,000.00

INITIAL INVESTMENT (AT YEAR 0)

Cost of New Building:
Repair Cost:
Total Cost of the New Building:
Less: Proceeds From Sale of Old Bldg., net of taxes:
(1,000,000-150,000)
Investment Tax Credit
Total Cost of Initial Investment at Year 0

Computation of Annual Depreciation

Total Cost of New Building:
Residual Value at the End of Life, before taxes:
Total Cost After Salvage Value
SYD:

=20[(20+1)/2)]
210

Year

Percentage

SYD
1 20/210
2 19/210
3 18/210
4 17/210
5 16/210
6 15/210
7 14/210
8 13/210
9 12/210
10 11/210
11 10/210
12 9/210
13 8/210
14 7/210
15 6/210
16 5/210
17 4/210
18 3/210
19 2/210
20 1/210
Total Depreciation

Cost, After Salvage Value

0.095
4,113,333.33
0.090
4,113,333.33
0.086
4,113,333.33
0.081
4,113,333.33
0.076
4,113,333.33
0.071
4,113,333.33
0.067
4,113,333.33
0.062
4,113,333.33
0.057
4,113,333.33
0.052
4,113,333.33
0.048
4,113,333.33
0.043
4,113,333.33
0.038
4,113,333.33
0.033
4,113,333.33
0.029
4,113,333.33
0.024
4,113,333.33
0.019
4,113,333.33
0.014
4,113,333.33
0.010
4,113,333.33
0.005
4,113,333.33

5,000,000.00
280,000.00
5,280,000.00
850,000.00
500,000.00
3,930,000.00

5,280,000.00
1,166,666.67
4,113,333.33

er Salvage Value

Depreciation
391,746.03
372,158.73
352,571.43
332,984.13
313,396.83
293,809.52
274,222.22
254,634.92
235,047.62
215,460.32
195,873.02
176,285.71
156,698.41
137,111.11
117,523.81
97,936.51
78,349.21
58,761.90
39,174.60
19,587.30
4,113,333.33

YEARLY INFLOWS (YEAR 1-19)

Year
Savings on Rental Cost
Incremental Rental Income
Total Incremental Cash Inflows, before taxes
Less: Depreciation
Total Net Income,before taxes
Tax Rate
Total Net Income After Taxes
Add: Depreciation
Total Incremetal Cash inflows, after taxes

INFLOWS FOR YEAR 20

Year
Savings on Rental Cost
Incremental Rental Income
Salvage Value, Before Tax
Total Incremental Cash Inflows, before taxes
Less: Depreciation
Total Net Income,before taxes
Tax Rate
Total Net Income After Taxes
Add: Depreciation
Total Incremetal Cash inflows, after taxes

1
420,000
540,000
960,000.00
391,746.03
568,253.97
60%
340,952.38
391,746.03
732,698.41

2
420,000
540000
960,000.00
372,158.73
587,841.27
60%
352,704.76
372,158.73
724,863.49

3
420,000
540,000
960,000.00
352,571.43
607,428.57
60%
364,457.14
352,571.43
717,028.57

4
420,000
540000
960,000.00
332,984.13
627,015.87
60%
376,209.52
332,984.13
709,193.65

5
420,000
540,000
960,000.00
313,396.83
646,603.17
60%
387,961.90
313,396.83
701,358.73

6
420,000
540000
960,000.00
293,809.52
666,190.48
60%
399,714.29
293,809.52
693,523.81

7
420,000
540,000
960,000.00
274,222.22
685,777.78
60%
411,466.67
274,222.22
685,688.89

8
420,000
540,000
960,000.00
254,634.92
705,365.08
60%
423,219.05
254,634.92
677,853.97

9
420,000.00
540,000.00
960,000.00
235,047.62
724,952.38
60%
434,971.43
235,047.62
670,019.05

INITIAL INVESTMENT (AT YEAR 0)

20.00
540,000.00
594,000.00
1,166,666.67
2,300,666.67
19,587.30
2,281,079.37
0.60
1,368,647.62
19,587.30
1,388,234.92

Cost of New Building:

Repair Cost:
Total Cost of the New Building:
Less: Proceeds From Sale of Old Bldg., net of taxes:
(1,000,000-150,000)
Investment Tax Credit
Total Initial Investment at Year 0

5,000,000.00
280,000.00
5,280,000.00
850,000.00
500,000.00
3,930,000.00

10
###
###
960,000.00
215,460.32
744,539.68
60%
446,723.81
215,460.32
662,184.13

11
540,000.00
594,000.00
1,134,000.00
195,873.02
938,126.98
60%
562,876.19
195,873.02
758,749.21

12
540,000.00
594,000.00
1,134,000.00
176,285.71
957,714.29
60%
574,628.57
176,285.71
750,914.29

13
540,000.00
594,000.00
1,134,000.00
156,698.41
977,301.59
60%
586,380.95
156,698.41
743,079.37

14
540,000.00
594,000.00
1,134,000.00
137,111.11
996,888.89
60%
598,133.33
137,111.11
735,244.44

15
540,000.00
594,000.00
1,134,000.00
117,523.81
1,016,476.19
60%
609,885.71
117,523.81
727,409.52

16
540,000.00
594,000.00
1,134,000.00
97,936.51
1,036,063.49
60%
621,638.10
97,936.51
719,574.60

17
540,000.00
594,000.00
1,134,000.00
78,349.21
1,055,650.79
60%
633,390.48
78,349.21
711,739.68

18
540,000.00
594,000.00
1,134,000.00
58,761.90
1,075,238.10
60%
645,142.86
58,761.90
703,904.76

19
540,000.00
594,000.00
1,134,000.00
39,174.60
1,094,825.40
60%
656,895.24
39,174.60
696,069.84

Requirement 1
Net present value
Year
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
TOTAL

Discount Rate
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%
14%

Present Value Factor

0.877
0.769
0.675
0.592
0.519
0.456
0.400
0.351
0.308
0.270
0.237
0.208
0.182
0.160
0.140
0.123
0.108
0.095
0.083
0.073

Cash Inflows (Outflows)

(3,930,000.00)
732,698.41
724,863.49
717,028.57
709,193.65
701,358.73
693,523.81
685,688.89
677,853.97
670,019.05
662,184.13
758,749.21
750,914.29
743,079.37
735,244.44
727,409.52
719,574.60
711,739.68
703,904.76
696,069.84
1,388,234.92

NPV
(3,930,000.00)
642,717.91
557,758.92
483,973.86
419,899.57
364,263.75
315,960.12
274,026.87
237,627.85
206,036.18
178,620.07
179,533.25
155,859.10
135,292.01
117,425.88
101,907.52
88,429.71
76,725.32
66,562.03
57,737.85
101,010.36
831,368.12

Internal Rate of Return

14%
Year
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Cash Flows (Inflows)

(3930000.00)
732,698.41
724,863.49
717,028.57
709,193.65
701,358.73
693,523.81
685,688.89
677,853.97
670,019.05
662,184.13
758,749.21
750,914.29
743,079.37
735,244.44
727,409.52
719,574.60
711,739.68
703,904.76
696,069.84
1,388,234.92

PV Factor
0.877
0.769
0.675
0.592
0.519
0.456
0.400
0.351
0.308
0.270
0.237
0.208
0.182
0.160
0.140
0.123
0.108
0.095
0.083
0.073

Total

Internal Rate of Returm =

0.1791

NPV
(3930000.00)
642,717.91
557,758.92
483,973.86
419,899.57
364,263.75
315,960.12
274,026.87
237,627.85
206,036.18
178,620.07
179,533.25
155,859.10
135,292.01
117,425.88
101,907.52
88,429.71
76,725.32
66,562.03
57,737.85
101,010.36
831,368.12

20%
PV Factor
0.833
0.694
0.579
0.482
0.402
0.335
0.279
0.233
0.194
0.162
0.135
0.112
0.093
0.078
0.065
0.054
0.045
0.038
0.031
0.026

NPV
(3930000.00)
610,582.01
503,377.43
414,947.09
342,010.83
281,860.34
232,259.72
191,363.18
157,647.17
129,854.18
106,946.43
102,118.53
84,220.03
69,451.08
57,265.66
47,212.86
38,920.27
32,080.42
26,439.39
21,787.59
36,210.79
-443,444.99

Profitability Index
Year

Total
PI =

Present Value of Future Cash Flows

1
642,717.91
2
557,758.92
3
483,973.86
4
419,899.57
5
364,263.75
6
315,960.12
7
274,026.87
8
237,627.85
9
206,036.18
10
178,620.07
11
179,533.25
12
155,859.10
13
135,292.01
14
117,425.88
15
101,907.52
16
88,429.71
17
76,725.32
18
66,562.03
19
57,737.85
20
101,010.36
4761368.1203
1.21

Undiscounted Payback Period:

Year

Cash Flows
1
2
3
4
5

Total

732,698.41
724,863.49
717,028.57
709,193.65
701,358.73
3,585,142.86

Payback Period:

5.00

3,930,000.00
-3,585,142.86
344,857.14
344857.14/693503.81

0.50
5.50

Years

Decision:

Yes, based on the figures achieved after applying the different capital budgeting
techniques, the investment of a new building to replace the older one is acceptable.
Payback Period is well within the the 20 year time period. In fact, it is very short (5.50
years only). The Net Present Value of the investment is 831,368.12. It is positive and
indicates that the investment is attractive and favorable. The Internal Rate of Return
the investment is 17.91%. It is more than the discount rate (14%) and therefore, the
investment is profitable. The investment also provides a favorable return per peso of
investment as shown with the Profitability Index of 1.21 (according to the PI criterion,
is more than 1, then it is desirable).

ifferent capital budgeting

e the older one is acceptable. The
od. In fact, it is very short (5.50
831,368.12. It is positive and
e. The Internal Rate of Return of
rate (14%) and therefore, the
a favorable return per peso of
1 (according to the PI criterion, if it