Between NPV and payback period, which capital budgeting technique should the CEO consider in making the decision
Question:
Between NPV and payback period, which capital budgeting technique should the CEO consider in making the decision and why? Which of these projects should be chosen? Discuss.
Sydney investment:
Formula | Year (n) | 0 | 1 | 2 | 3 | 4 |
Cash flow (CF) | -2,000,000 | 800,000 | 1,000,000 | 1,000,000 | 1,000,000 | |
Discount factor @ 10% | 1.000 | 0.909 | 0.826 | 0.751 | 0.683 | |
CF*Discount factor | Discounted cash flow (DCF) | -2,000,000 | 727,272.73 | 826,446.28 | 751,314.80 | 683,013.46 |
Sum of all DCFs | NPV | 988,047.26 | ||||
Formula | Year (n) | 0 | 1 | 2 | 3 | 4 |
Cash flow (CF) | -2,000,000 | 800,000 | 1,000,000 | 1,000,000 | 1,000,000 | |
CFn + CCFn-1 | Cumulative Cash flow (CCF) | -2,000,000 | -1,200,000 | -200,000 | 800,000 | 1,800,000 |
(-CCFYear2/CFYear3) + 2 | Payback period (in years) | 2.20 |
Melbourne investment:
Formula | Year (n) | 0 | 1 | 2 | 3 | 4 |
Cash flow (CF) | -2,000,000 | 1,000,000 | 1,000,000 | 700,000 | 700,000 | |
1/(1+discount rate)^n | Discount factor @ 10% | 1.000 | 0.909 | 0.826 | 0.751 | 0.683 |
CF*Discount factor | Discounted cash flow (DCF) | -2,000,000 | 909,090.91 | 826,446.28 | 525,920.36 | 478,109.42 |
Sum of all DCFs | NPV | 739,566.97 | ||||
Formula | Year (n) | 0 | 1 | 2 | 3 | 4 |
Cash flow (CF) | -2,000,000 | 1,000,000 | 1,000,000 | 700,000 | 700,000 | |
CFn + CCFn-1 | Cumulative Cash flow (CCF) | -2,000,000 | -1,000,000 | 0 | 700,000 | 1,400,000 |
(-CCFYear1/CFYear2) + 1 | Payback period (in years) | 2.00 |
Fundamentals of Financial Management
ISBN: 978-0324597707
12th edition
Authors: Eugene F. Brigham, Joel F. Houston