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Capital Budgeting Methods

Compare the results of the three (3) methods by quality of information for
decision making. Using what you have learned about the three (3) methods,
identify the best project by the criteria of long term increase in value. (You
do not need to do further research.) Convey your understanding of the Time
Value of Money principles used or not used in the three (3) methods. Review the
video titled “NPV, IRR, MIRR for Mac and PC Excel” (located at.youtube.com/watch?v=C7CryVgFbBc”>https://www.youtube.com/watch?v=C7CryVgFbBc and previously listed in Week 4) to help you understand the
foundational concepts:

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is
the Cash Flow in the first year, and CF2 is the Cash Flow in the second year.
This is the time line and data used in calculating the Payback Period, Net
Present Value, and Internal Rate of Return. The calculations are done for you.
Your task is to select the best project and explain your decision. The methods
are presented and the decision each indicates is given below.


Sales Price



Gas Station A




Gas Station B




Three (3) Capital Budgeting Methods are presented:

Payback Period:
Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2.
Gas Station B is paid back in one (1) year. According to the payback
period, when given the choice between two mutually
exclusive projects, the investment paid back in the shortest time is
Net Present Value:
Consider the gas station example above under the NPV method, and a
discount rate of 10%:
NPVgas station A = $100,000/(1+.10)2 – $50,000 = $32,644
NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2
– $50,000 = $16,115
Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station
A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

Gas Station B should be selected, as the investment is
returned in 1 period rather than 2 periods required for Gas Station A.
Under the NPV criteria, however, the decision favors
gas station A, as it has the higher net present value. NPV is a measure of
the value of the investment.
The IRR method favors Gas Station A. as it has a higher
return, exceeding the cost of funds (10%) by the highest return.

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