International Center For Environmental Finance. Environmental Finance Policy Presentation #?: Capital Budgeting Decisions. CAPITAL BUDGETING.
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Environmental Finance Policy
Capital Budgeting Decisions
Moscow City Vodokanal is considering the purchase of a machine that will bring cash revenues of $20,000 per year. Cash costs (including taxes) will be $14,000 per year. The life of the machine is 8 years and its salvage cost will be $2,000. The project cost $30,000 to launch. We will use 15% discount rate.
To see if this investment is acceptable we have to perform Net Present Value Analysis
$20,000-$14,000=$6,000 per year, along with a single lump-sum inflow of $2,000 in eight years.
Present Value = $6,000x[1-(1/1.158)/0.15+
+(2,000/1.158)=($6,000 x 4.4873)+
When we compare this to the $30,000 estimated cost ,we se that the NPV is:
NPV=-$30,000 + 27,578 = -$2,422
Therefore, this is not a good investment
$2,422/1,000 = $2,42 per share
Now let us consider an example that has different cash inflows in different periods.
WHAT SHOULD WE DO?
Present Value = ($2,000/1.1) + (2,000/1.12) +
+ (4,000/1.13) + (4,000/1.14) + (5,000/1.15)=
= $1,818 + 1,653 + 3,005 + 2,732 + 3,105 =
NPV = $12,313 – 10,000 - $2,313
Discounted Cash Flows –The Internal Rate of Return Method
Internal rate of Return Method
Net Present Value Method
Other Approaches to Capital Budgeting Decisions
Which Machine should be purchased?
GorVodokanal should purchase machine B, since it has a shorter payback period than A.