International Center For Environmental Finance. Environmental Finance Policy Presentation #?: Capital Budgeting Decisions. CAPITAL BUDGETING.
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
Internal rate of Return Method
Net Present Value Method
Which Machine should be purchased?
GorVodokanal should purchase machine B, since it has a shorter payback period than A.