Question

evaluate alternative capital projects

Answer 1

Capital budgeting is the process of making long- term investment decision. It is decision making process that enables a firm evaluate the viability of a long – term project whether it is worth or not.

Capital budgeting techniques

1. Payback period – it is the length of time. It takes for the initial cash outlay for the investment to be recovered in cash.

Formula = initial investment ÷ Annual cash flow

2. Accounting Rate of Return (ARR) – it is a method that computes an approximate rate of return which ignores the time value of money and does not consider actual cash flows. It is also called return on investment.

Formula = Average net profit ÷ Average investment

3. Internal Rate of Return – it is the discount rate at which the net present value is zero. It is where the rate of interest equates the present value of cash inflows and outflows.

Formula = Initial investment ÷ Net cash flows

4. Net Present Value (NPV) – it is the excess of the present value of the cash inflows over cash outflows.

Formula = NPV = (R_t ÷ 1+i^t)

T – Time of cash flow

I – discount rate

R_{t –} net cash flows