Capital budgeting is an important topic and there are Websites designed to help people understand the methods available. Access TeachMeFinance.com’s capital budgeting Webpage (teachmefinance.com/capitalbudgeting.html). This Webpage contains an example of a capital budgeting case involving a $15,000 initial cash outflow.
Required
Compute the payback period and the net present value (assuming a 10% required rate of return) of the following investment—assume that its cash flows occur at year-end. Compared to the example case at the Website, the larger cash inflows in the example below occur in the later years of the project’s life. Is this investment acceptable based on the application of these two capital budgeting methods? Explain.
Year Cash Flow
0 . . . . . . . . . . $(15,000)
1 . . . . . . . . . . . . 1,000
2 . . . . . . . . . . . . 2,000
3 . . . . . . . . . . . . 3,000
4 . . . . . . . . . . . . 6,000
5 . . . . . . . . . . . . 7,000