BF LAS 7 For Reproduction

Republic of the Philippines
Department of Education
Region III - Central Luzon
Schools Division of Tarlac Province
Marawi National High School
Camiling, Tarlac
Business Finance
Quarter 3 – Module 7:
Capital Budgeting
Name of Student:
___________________________________________________
Grade & Section:
___________________________________________________
1
Page

Marawi, Camiling, Tarlac
Contact No.: (045) 800-9003
Email Address: 300972.marawinhs@deped.gov.ph
Camiling, Tarlac
What I Need to Know
This module is designed and written to understand the different tools in

computing finance and investment problems like payback method, net present
value, and internal rate of return.
After going through this module, you are expected to apply mathematical
concepts and tools in computing for finance and investment problems. (ABM_BF12-
IIIg-h-21).
Specifically, you are going to:
1. define capital budgeting;

2. compute for the payback method and net present value; and
3. apply mathematical concepts and tools in computing for finance and
investment problems. (ABM_BF12-IIIg-h-21).
Lesson 1: Capital Budgeting
Every businessman should plan and decide where his resources would go
and what would be the benefits of his decision. He may also decide to acquire long-
term investments such as additional units of the plant, property and equipment,
replacement of machine or purchasing fixed assets. All these decisions require the
use of capital budgeting tools and equipment.
Capital Budgeting
Capital budgeting is the process that a business uses in evaluating and

selecting major projects or investment. It involves capital investments proposal
evaluation, allocation of capital investment funds among approved projects and
programs, and control of such expenditures. Capital expenditures are a long-term
investment.
2
Page

Contact No.: (045) 800-9003
Camiling, Tarlac
Steps in Capital Budgeting
1
Investment 2
Proposal
All levels within the Review and Analysis 3
organization are of the Proposal
encouraged to make
suggetions for capital The financial Decision-making 4
personnels review and
expenditures
analyze the benefits
and costs that may be
The analysis will be
presented to decide Implementation 5
derived from the whether the proposal
After being approved,
proposal using the will push or not.
the funds will be Monitoring
financial tools. available and the
project will be The actual costs are
recorded, reported
operational.
and compared with
the budgeted figures.
Corrective measures
may be required if
there are some
deviations.
What Is It
Terms related to capital budgeting:

1. Exclusive Projects
a. Independent projects do not compete with other projects.
Example: Project Proposal A is for increasing the sales volume of Product A.
Project Proposal B is for the opening of a new outlet in Mindanao.
b. Mutually exclusive projects compete with other projects and the
approval of one eliminates the other projects.
Example: Project Proposals A and B are presented to increase the sales
volume of the product. If Project Proposal A is accepted, Project B will be
eliminated.
2. Capital Rationing and Unlimited Funds

a. The business with capital rationing will choose a project with the best
opportunities.
b. If the business has unlimited funds, it will accept all the projects that
pass the risk-return criteria.
3
Page

Contact No.: (045) 800-9003
Camiling, Tarlac
3. Cash Returns
These are the net cash inflows one expects to get when the business or
project has already started.
Tools in Capital Budgeting
1. Payback Method
It is a method that evaluates a project by measuring the time (usually
expressed in years) it will take to recover the initial investments.
Even Cash Flow
Example 1: ABCD Company is considering a project requiring an initial investment of
Php 120,000.00. The project is expected to realize annual cash returns of Php
25,000.00 for 6 years. Calculate the payback period of the project.
Payback period = Initial Investment / Annual Cash returns
= Php 120,000.00 / Php 25,000.00
= 4.8 years.
In this example, ABCD Company will accept the project because the payback
period is 4.8 years shorter than 6 years.
Uneven Cash Returns

When the cash returns are uneven, the payback period is computed
by adding the cash returns until the total is equal to the investment.
Example 2: ABCD Company is planning to undertake another project with an initial
investment of Php 100,000.00. It is expected to receive net cash returns of Php 25,000.00
in Year 1; Php 30,000.00 in Year 2; Php 35,000.00 in Year 3;
Php 40,000.00 in Year 4; and Php 45,000.00 in Year 5.
We already recovered Php
90,000.00 by adding the cash returns
in year 1, 2 and 3. We only need Php
10,000.00 to reach the initial
investment of
Php100,000.00. So in Year 4, we only
need Php 10,000.00 from the Php
40,000.00 projected cash return,
which is 0.25 or 25% of the annual cash
return.
4
Page
The payback period is 3.25 years (3 + 0.25).

Contact No.: (045) 800-9003
Camiling, Tarlac
2. Net Present Value (NPV)

This refers to the difference between the present value of cash inflows and
the net present value of cash outflows over a period. It is used in capital budgeting
and investment planning to analyze if the project is profitable or not.
If the NPV is positive, the project or investment should be accepted. If it is
negative, it means that it will result to a loss so it should be rejected.
You can use the PVIFA

table in page 9. Locate 6
years at 7%.
3. Internal Rate of Return (IRR)

The IRR is the most used technique in capital budgeting. It is defined as the
discount rate that makes the net present value of an investment equals to zero.
Example 4: ABCD Company is evaluating the profitability of Project A. It requires Php
100,000.00 of funding and after one year, the company is expected to receive Php
125,000.00. Compute for the internal rate of return.
IRR = Php 25,000.00/Php 100,000.
00 = .25 or 25% NPV = Php 125,
5
000/(1+.25) – Php 100,000.00 = 0

Page

Contact No.: (045) 800-9003
Camiling, Tarlac
6
Page

Contact No.: (045) 800-9003
Camiling, Tarlac
Activity 7
A: Solve the problem below and answer the questions that

follow.
Two investment proposals have been made and the following
data are given below:
Yea Project X Project Y

r
0 (Php (Php
50,000.00) 75,000.00)
1 Php Php
15,000.00 24,000.00
2 Php Php
20,000.00 24,000.00
3 Php Php
25,000.00 24,000.00
4 Php Php
30,000.00 24,000.00
1. What is the payback period of each proposal? (4 points)

_______________________________________________________
_______________________________________________________
_______________________________________________________
2. Compute for the net present value of each proposal if the cost of
capital is 10%. (4 points)
_______________________________________________________
_______________________________________________________
_______________________________________________________
3. Which project should be accepted? Why? (2 points)
_______________________________________________________
_______________________________________________________
7
Page
_______________________________________________________

Contact No.: (045) 800-9003
Camiling, Tarlac
B: Write T if the statement is correct and write F if the

statement is incorrect.
______1. Capital budgeting is the process that a business use in
evaluating and selecting major projects or investment.
______2. Payback method evaluates a project by measuring the time

(usually in years) it will take to recover the initial investments.
______3. Independent projects compete with one another and the approval
of one eliminates the other projects.
______4. Internal rate of return refers to the difference between the present
value of cash inflows and the net present value of cash outflows over a
period.
______5. Cash returns are the net cash inflows one expects to get when
the business or project has already started.
______6. Net present value is defined as the discount rate that makes the
net present value of an investment equals to zero.
______7. If the net present value is negative, the project should be

rejected.
______8. If the net present value is positive, the project should be

accepted.
______9. Mutually exclusive projects are those projects that do not

compete with other projects.
______10. When the cash returns are even, the payback period is
computed by adding the cash returns until the total is equal to the
investment.
8
Page

Contact No.: (045) 800-9003

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Republic of the Philippines

Grade & Section:

Marawi National High School

What I Need to Know

This module is designed and written to understand the different tools in

Specifically, you are going to:

1. define capital budgeting;

Lesson 1: Capital Budgeting

Capital budgeting is the process that a business uses in evaluating and

Marawi National High School

Steps in Capital Budgeting

Terms related to capital budgeting:

2. Capital Rationing and Unlimited Funds

Marawi National High School

Tools in Capital Budgeting

Uneven Cash Returns

The payback period is 3.25 years (3 + 0.25).

Marawi National High School

2. Net Present Value (NPV)

You can use the PVIFA

3. Internal Rate of Return (IRR)

000/(1+.25) – Php 100,000.00 = 0

Marawi National High School

Marawi National High School

A: Solve the problem below and answer the questions that

Yea Project X Project Y

1. What is the payback period of each proposal? (4 points)

Marawi National High School

B: Write T if the statement is correct and write F if the

______2. Payback method evaluates a project by measuring the time

______7. If the net present value is negative, the project should be

______8. If the net present value is positive, the project should be

______9. Mutually exclusive projects are those projects that do not

Marawi National High School

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