FIBA500: Financial management
Student name: Rania Nader
Student ID: 123016132
I. Explanation of capital budgeting techniques :
1- Payback period :
In capital budgeting for a business firm, historically, the payback period is the criteria that most business firm uses to select capital projects. Even today, small businesses find the payback period selection criteria most useful.
The definition of payback period : The payback period is the number of years it takes to payback the initial investment of a capital project from the cash flows that the project produces.
Calculating Payback Period:
Usually small businesses prefer a simple calculation:
Payback Period = Investment Required/Net Annual Cash Inflow*
Large firms prefer a more complex calculation for payback:
Payback Period = Number of years prior to full recovery of investment + Unrecovered cost at start of year/Cash flow during full recovery year
Machine A costs $20,000 and the firm expects payback at the rate of $5,000 per year, Machine B costs $12,000 and the firm expects payback at the same rate as Machine A.
Machine A = $20,000/$5,000 = 4 years
Machine B = $12,000/$5,000 = 2.4 years
So the firm would choose Machine B.
2-Net Present Value (NPV):
Definition: The difference between the present value of cash inflows and the present value of cash outflows, and is used to analyze the profitability of an investment or project.
NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield, it’s very reliable measure because it considers the time value of money by using discounted cash inflows.
We have the following two formulas for the calculation of NPV:
When cash inflows are even:
NPV = R × | 1 − (1 + i)-n | − Initial Investment |
| I | |
R: net cash inflow expected to be received each period
i: required rate of return per period
n: number of periods during which the project is expected...