Capital Budgeting Calculator

The Capital Budgeting Calculator is a crucial tool for businesses and investors that aids in evaluating the profitability and feasibility of potential investment projects. Capital budgeting is the process of analyzing and selecting investment projects that will yield the best returns over time. This calculator helps decision-makers assess various investment options by providing essential metrics such as Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index (PI). By utilizing these calculations, organizations can make informed financial decisions, ensuring that capital is allocated efficiently and effectively.

Formula of Capital Budgeting Calculator

Capital budgeting involves evaluating investment projects to determine their profitability. The following are key formulas used in capital budgeting:

Net Present Value (NPV):
NPV = ∑ (Ct / (1 + r)^t) – C0

Internal Rate of Return (IRR):
0 = ∑ (Ct / (1 + IRR)^t) – C0

Payback Period:
Payback Period = Years before full recovery + (Unrecovered Amount / Cash Flow in Recovery Year)

Profitability Index (PI):
PI = ∑ (Ct / (1 + r)^t) / C0

where:

• Ct is the cash inflow at time t
• C0 is the initial investment
• r is the discount rate (for NPV and PI)
• t is the time period (in years)
• IRR is the rate at which NPV = 0
• Unrecovered Amount is the remaining balance to be recovered in the final year
• Cash Flow in Recovery Year is the cash inflow in the year when the investment is fully recovered

General Terms Table

The following table provides common terms related to capital budgeting and financial analysis. This can serve as a helpful reference for users without needing to perform calculations each time.

Example of Capital Budgeting Calculator

To illustrate the use of the Capital Budgeting Calculator, consider a company evaluating a new project with the following data:

• Initial Investment (C0): $100,000
• Expected Cash Inflows (Ct) over the next 5 years:
  • Year 1: $30,000
  • Year 2: $35,000
  • Year 3: $40,000
  • Year 4: $45,000
  • Year 5: $50,000
• Discount Rate (r): 10%

Step 1: Calculate NPV

NPV = ∑ (Ct / (1 + r)^t) – C0
NPV = (30,000 / (1 + 0.10)^1) + (35,000 / (1 + 0.10)^2) + (40,000 / (1 + 0.10)^3) + (45,000 / (1 + 0.10)^4) + (50,000 / (1 + 0.10)^5) – 100,000
NPV = 27,272.73 + 28,925.62 + 30,421.90 + 30,888.73 + 31,396.34 – 100,000
NPV = 148,905.32 – 100,000
NPV ≈ $48,905.32

Step 2: Calculate IRR

The IRR is calculated by finding the discount rate that makes NPV = 0. This typically requires iterative methods or financial calculators.

Step 3: Calculate Payback Period

To find the payback period, add up the cash inflows until the initial investment is recovered:

• Year 1: $30,000 (cumulative: $30,000)
• Year 2: $35,000 (cumulative: $65,000)
• Year 3: $40,000 (cumulative: $105,000)

The payback period is between Year 2 and Year 3. Specifically, it takes:

Payback Period = 2 + ($100,000 – $65,000) / $40,000
Payback Period = 2 + $35,000 / $40,000
Payback Period = 2 + 0.875
Payback Period ≈ 2.875 years

Step 4: Calculate Profitability Index

PI = ∑ (Ct / (1 + r)^t) / C0
PI = 148,905.32 / 100,000
PI ≈ 1.489

In this example, the project has a positive NPV of approximately $48,905.32, an IRR that would need calculation, a payback period of about 2.875 years, and a profitability index of 1.489. This suggests that the project is likely a good investment.

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