The document discusses various capital budgeting methods including average return on investment, payback period, net present value, internal rate of return, modified internal rate of return, and profitability index. It provides examples of how to calculate each method and compares the advantages and disadvantages. It also discusses how to estimate cash flows, evaluate capital projects, and conduct sensitivity analysis.

15. Profitability Index PI = PV of all Benefits PV of all Cost Example : PV (Benefits) = 26000 + 28000 +.......... + 18000 1.1 (1.1) 2 (1.1) 6 = 125121 PV (Cost) = 100000 PI = 125121 = 1.25 100000

22. Modified IRR Reinvestment Rate Assumption (Project A) Project Outlay 25,000 Cash Flows: YR1 2,000 YR2 2,000 YR3 35,000 NPV @ 8%: 6,351 IRR: 17%

23. NPV: Project A YR1: 2,000 YR2: 2,000 + 2,000 + 160 = 4,160 YR3: 35,000 + 4,160 + 333 = 39,493 [Note: PV of 39,493, three years from now @ 8% = 31,351 Less: outlay 25,000 NPV 6,351] Modified IRR

24. IRR @ 17% YR1: 2,000 = 2,000 YR2: 2,000 + 2,000 + 340 = 4,340 YR3: 35,000 + 4,340 + 738 = 40,078 [25,000 invested for three years @ 17% = 25,000(1.17) 3 = 40,040] Modified IRR

25. Modified Internal Rate of Return Find k such that (1+k) n I 0 = Final value i.e. (1+k) 3 25000 = 39,439 k = 16.5% Modified IRR

26. Reinvestment Rate Assumption (Project B) Project Outlay 25,000 Cash Flows: YR1 21,000 YR2 10,000 YR3 2,000 NPV @ 8%: 4,606 IRR: 22.12% Modified IRR

27. NPV: Project B YR1: 21,000 = 21,000 YR2: 10,000 + 21,000 + 1,680 = 32,680 YR3: 2,000 + 32,680 + 2,614 = 37,294 [Note: PV of 37,294, three years from now @ 8% = 29,606 Less: outlay 25,000 NPV 4,606 ] Modified IRR

28. IRR of 22.12% YR1: 21,000 = 21,000 YR2: 10,000 + 21,000 + 4,645 = 35,645 YR3: 2,000 + 35,645 + 7,885 = 45,530 [25,000 invested for three years @ 22.12% = 25,000(1.2212)3 = 45,530] Modified IRR

29. Modified Internal Rate of Return Find k such that (1+k) n I 0 = Final value i.e. (1+k) 3 25000 = 37,294 k = 14.26% Modified IRR