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# Expenditure :
Capital Expenditure : An outlay of funds by the firm
that is expected to produce benefits over a period of
time greater than one year.
Current Expenditure : An outlay of funds by the firm
resulting in benefits received within one year.
1. Payback Period
Payback Periods are a commonly used criterion for
evaluating proposed investments.
The Payback Period is the exact amount of time
required for the firm to recover its initial investment in a
project as calculated from cash inflows.
In the case of an annuity, the Payback Period can be
found by dividing the initial investment by the annual
cash inflow .
For a mixed stream, the yearly cash inflows must be
accumulated until the initial investment is recovered.
Where , YFR
=Year of full recovery
CCF YFR = Cumulative CF at the start of year of full
recovery
CF YFR
= Cash flow during YFR
Payback Period is generally viewed as an
unsophisticated capital budgeting technique, because it
does not explicitly consider the time value of money by
discounting cash flows to find the present value. Payback
period also ignores cash flows beyond payback period.
## Interpolation
IRR = L + A X (H - L)
B
L= Lower discounting rate, H = Higher discounting rate
A= NPV at lower discount rate
B = Difference between the PV of all net cash benefits at
lower
discounting rate and higher rate , OR
NPV at lower discount rate NVP at higher discount
rate
Problem - 1
Capital Budgeting : Replacement Decision
# A machine purchased six years ago for $ 150000
has been depreciated to a book value of $ 90000.
It originally had a projected life of 15 years and
zero salvage value. A new machine will cost $
250000 and result in a reduced operating cost of $
30000 per year for the next nine years. The older
machine could be sold for $ 50000. The cost of
capital is 10%. The new machine will be
depreciated on a straight line basis over nine years
life with $ 25000 salvage value. The company tax
rate is 55%. Determine whether the old machine
should be replaced
Replacement Decision:
Whether to purchase capital assets to take the place
of existing assets to maintain or improve existing
operations.
Expansion Decisions :
Whether to purchase capital projects and add them
to existing assets to increase existing operations
Independent Projects :
Projects whose cash flows are not affected by
decision made about other projects.