# U05a1

### Capital Budgeting Measurement Criteria

#### Introduction

In this assignment, you will learn about the capital budgeting process, which is basically how companies evaluate their investment in various projects, such as buying new machinery or expanding into a new plant. In addition, you will learn about the following techniques used in capital budgeting:

• Net Present Value.
• Internal Rate of Return.
• Modified Internal Rate of Return.
• Payback Period.
• Discounted Payback Period.
• Profitability Index.

#### Instructions

Answer the following questions and complete the following problems, as applicable.

You may solve the following problems algebraically, or you may use a financial calculator or Excel spreadsheet. If you choose to solve the problems algebraically, be sure to show your computations. If you use a financial calculator, show your input values. If you use an Excel spreadsheet, show your input values and formulas.

1. Describe the Net Present Value (NPV) method for determining a capital budgeting project’s desirability. What is the acceptance benchmark when using NPV?

2. What is the payback period statistic? What is the acceptance benchmark when using the payback period statistic?

3. Describe the Internal Rate of Return (IRR) method for determining a capital budgeting project’s desirability. What is the acceptance benchmark when using IRR?

4. Describe the Modified Internal Rate of Return (MIRR) method for determining a capital budgeting project’s desirability. What are MIRR’s strengths and weaknesses?

5. Compute the NPV statistic for Project Y and tell [advise] whether the firm should accept or reject the project with the cash flows shown in the chart if the appropriate cost of capital is 12 percent.

#### Project Y

Time 0 1 2 3 4
Cash Flow -\$11,000 \$3,350 \$4,180 \$1,520 \$2,000

6. Compute the payback period statistic for Project B and decide whether the firm should accept or reject the project with the cash flows shown in the chart if the maximum allowable payback is three years.

#### Project B

Time 0 1 2 3 4 5
Cash Flow -\$11,000 \$3,350 \$4,180 \$1,520 \$950 \$1,000