Question

If I want to make a capital budget purchase for an ultrasound machine that costs 150K, what approach would we use to see if it makes sense and what would the calculation look like for the NPV, IRR and PB to see if the project is worth it.

Answer 1

Hello Sir/Mam

You should always use the NPV approach to evaluate project as NPV provides solutions to the limitations od IRR method and Payback Period Method.

Evaluating a capital budgeting purchase using NPV, IRR and PB methods :

As specified in question, cost of purchase of machine is $150,000.

The calculation for the evaluation will look something like this:

Let the machine produces $50,000 annual cashflows for 4 years and our required rate of return = 15%.

NPV

Time Period	Amount	Present Value Factor	Present Value
0	-$150,000.00	1.0000	-$150,000.00
1	$50,000.00	0.8696	$43,478.26
2	$50,000.00	0.7561	$37,807.18
3	$50,000.00	0.6575	$32,875.81
4	$50,000.00	0.5718	$28,587.66
5	$50,000.00	0.4972	$24,858.84
Total			$17,607.75

IRR

Time Period	Amount	Present Value Factor	Present Value
0	-$150,000.00	1.0000	-$150,000.00
1	$50,000.00	0.8343	$41,716.13
2	$50,000.00	0.6961	$34,804.71
3	$50,000.00	0.5808	$29,038.36
4	$50,000.00	0.4845	$24,227.36
5	$50,000.00	0.4043	$20,213.44
Total			$0.00

IRR = 19.86% and can be easily calculated using the excel formula "=IRR(Range of Cashflows)".

PB

Time Period	Amount	Cumulative Cash Flows
0	-$150,000.00	-$150,000.00
1	$50,000.00	-$100,000.00
2	$50,000.00	-$50,000.00
3	$50,000.00	$0.00
4	$50,000.00	$50,000.00
5	$50,000.00	$100,000.00
Total

Hence, payback period = 3 years

I hope this solves your doubt.

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