Capital Budgeting if the Project

Capital Budgeting If the project has a discount rate of 0%, then the net present value will be the sum of the cash flows. This is $260,000. When we introduce a discount rate, we decrease the value of the future cash flows. So with a 4% discount rate, the net present value is $186,803; with an 8% discount rate the net present value is $123,507.60; and with a 10% discount rate the net present value is $95,041.32. The project's internal rate of return is 18%.

The graph shows that the project will continue to decline in net present value until the point of 18% discount rate. Any discount rate higher than 18% will bring the net present value into the negative, because the value of the future cash flows is so low that it does not make up for the initial investment. Thus, 18% is the point where the net present value intersects the horizontal axis. b. If the discount rate is 0%, the net present value of the project is $126, 000.

If the discount rate is 4%, the net present value of the project is $64,642. If the discount rate is 8%, then the net present value of the project is $10,906. If the discount rate is 12%, the net present value of the project is ($36,414). The graph shows that the project's future cash flows are $126,000. As the discount rate increases, the value of these future cash flows decreases. The point at which the curve intersects with the horizontal axis is at 9%.

Thus, any discount rate higher than 9% will give a negative net present value, as we can see by the position of the curve at 12%, which is negative $36,414. Any discount rate lower will yield a positive net present value, up to $126,000. Part II. For capital budgeting decisions, NPV is a better metric. NPV and IRR are very similar in many respects, and they carry the same reliance on the same underlying assumptions about the underlying cash flows. Additionally, they both relate to the company's cost of capital.

IRR is typically used as a go/no-go threshold, whereas NPV measures the raw cash flows. Ultimately, for most companies they objective is to generate superior returns for their shareholders. What NPV does that IRR does not do is consider the cash return of the project. With limited funds to go around, management will typically need to decided between a variety of different projects. Some will be approved and others will not be approved.

In order to meet the needs of the shareholders, management needs to approve the projects that contribute the most to the bottom line. IRR can skew.