Business Finance

Quarter 4 – Week 1:
Capital Budgeting
Business Finance – Grade 12
Alternative Delivery Mode
Quarter 4 – Module 7: Capital Budgeting
First Edition, 2020

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Business Finance
Quarter 4 – Week 1:
Capital Budgeting
Introductory Message
This Self-Learning Module (SLM) is prepared so that you, our dear learners,
can continue your studies and learn while at home. Activities, questions, directions,
exercises, and discussions are carefully stated for you to understand each lesson.

Each SLM is composed of different parts. Each part shall guide you step-by-
step as you discover and understand the lesson prepared for you.

Pre-tests are provided to measure your prior knowledge on lessons in each

SLM. This will tell you if you need to proceed on completing this module or if you
need to ask your facilitator or your teacher’s assistance for better understanding of
the lesson. At the end of each module, you need to answer the post-test to self-check
you’re learning. Answer keys are provided for each activity and test. We trust that
you will be honest in using these.

In addition to the material in the main text, Notes to the Teacher are also
provided to our facilitators and parents for strategies and reminders on how they can
best help you on your home-based learning.

Please use this module with care. Do not put unnecessary marks on any part
of this SLM. Use a separate sheet of paper in answering the exercises and tests. And
read the instructions carefully before performing each task.

If you have any questions in using this SLM or any difficulty in answering the
tasks in this module, do not hesitate to consult your teacher or facilitator.

Thank you.
 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).

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 What I Know

A. Directions: Choose the letter of the best answer. Write your answers on a separate
sheet of paper.

1. It is a method that evaluates a project by measuring the time (usually

expressed in years) it will take to recover the initial investments.
A. internal rate of return C.net present value
B. payback method D. none of the above
2. It is the process that a business use in evaluating and selecting major projects
or investment.
A. capital budgeting C. planning
B. marketing D. expenditures
3. These are competing projects that the approval of one eliminates the others.
A. independent projects C. subdivision projects
B. mutually exclusive projects D. combined projects
4. These are the net cash inflows one expects to get when the business or project
has already started.
A. cash returns C. cash receipts
B. cash refund D. cash disbursement
5. This refers to the difference between the present value of cash inflows and the
net present value of cash outflows over a period.
A. internal rate of return C. net present value
B. payback method D. none of the above

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B. Directions: Fill in the blank with the correct answer. Write the letter of your
answer on a separate sheet of paper.

6. The discount rate that makes the net present value of an investment equals
to zero is called .
A. internal rate of return C. net present value
B. payback method D. none of the above
7. The projects that do not compete with other projects are called .
A. independent projects C. subdivision projects
B. mutually exclusive projects D. combined projects
8. If the net present value is _, the project should be accepted.
A. even C. positive
B. uneven D. negative
9. If the net present value is _ , the project should be rejected.
A. even C. positive
B. uneven D. negative
10. When the cash returns are , the payback period is computed by
adding the cash returns until the total is equal to the investment.
A. even C. positive
B. uneven D. negative

A. Directions: Arrange the following steps in capital budgeting in order from

numbers 1 to 5. Write your answers on a separate sheet of paper.

11. Review and Analysis

12. Investment Proposal
13. Decision-making
14. Monitoring
15. Implementation

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 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.

What’s In

Directions: Arrange the following jumbled letters to form the correct word or
phrase based on the given clues. Write your answers on a separate
sheet of paper.

1.

It is a method that evaluates a project by measuring the time (usually

expressed in years) it will take to recover the initial investments.

2. A S H C T R U N E R S

These are the net cash inflows one expects to get when the business
or project has already started.

3. T E N S N E T E R P V U A L E

This refers to the difference between the present value of cash inflows
and the net present value of cash outflows over a period.

4. N I N A L T E R A T E R F O R T T U N E

It is defined as the discount rate that makes the net present value of
an investment equals to zero.

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 What’s New

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.

Steps in Capital Budgeting

1
Investment 2
Proposal
All levels within Review and 3
the organization Analysis of the
are encouraged to
make suggetions
Proposal Decision-making 4
The financial
for capital
expenditures
personnels review
and analyze the
The analysis will
be presented to Implementation 5
decide whether the
benefits and costs After being
proposal will push
that may be approved, the Monitoring
or not. funds will be
derived from the The actual costs
proposal using available and the
are recorded,
the financial tools. project will be
reported and
operational. compared with
the budgeted
figures. Corrective
measures may be
required if there
are some
deviations.

Source: Business Finance Teaching Guide

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 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. 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.

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

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.

Example 3: ABCD Company is considering which project it should accept. Project A requires an initial
investment of Php 120,000.00 and expects to realize an annual cash return of Php 25,000.00 for 6 years.
Project B requires an initial investment of Php 130,000.00 and the expected annual cash return is
Php 28,000.00 for 6 years. Compute for the NPV of both projects if the cost of capital is 7%.

You can use the

PVIFA table in page 9.
Locate 6 years at 7%.

Project A has a negative NPV while Project B has positive NPV. Project B should be accepted.
Another formula can be used in computing the net present value (even or uneven cash returns.) Let us
use Project A as an example.
Present Value
Cash Returns Cash Returns
= -Initial Investment + + + …..
(1+r)1 (1+r)2
Php 25,000.00 Php 25,000.00 Php 25,000.00 Php 25,000.00 Php 25,000.00 Php 25,000.00
= -Php 120, 000.00 + + + + + +
(1+07)1 (1+07)2 (1+07)3 (1+07)4 (1+07)5 (1+07)6
= -Php 120, 000.00 + Php 23, 364.49 + 21, 835.97 + 20, 407.45 + 19, 072.38 + 17, 824.65 + 16, 658. 56
= Php 120, 000.00 – Php 119,163.50
= (Php 836.50)

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 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, 000/(1+.25) – Php 100,000.00 = 0

What’s More

Directions: Solve the problem below. Show your solution on a separate sheet
of paper.

Two project proposals have been presented to XYZ Corporation. Project A

requires an initial investment of Php 80,000.00 and the expected annual cash return
is Php 30,000.00 for 4 years. Project B requires an initial investment of
Php 60,000.00 and the expected annual cash return is Php 20,000.00 for 5 years.

a. What is the payback period of each project? (4 points)

b. Compute for the net present value of each project if the cost of capital
is 10%. (4 points)
c. Which project should XYZ Corporation accept? Why? (2 points)

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9

Adapted from Mathematics of Investment, del Rosario, 1999

 What I Have Learned

Directions: Answer the following questions in one (1) to two (2) sentences. Write your
answers on a separate sheet of paper.

In this lesson,

I learned:

I did that:

I realized:

Scoring Rubrics:

5 points The answer is well-written, organized and the idea is very relevant
to the question and has no grammatical or spelling errors.

4 points The answer is fairly written, and the idea is almost relevant to the
question and has one grammatical or spelling error.

3 points The answer is somewhat relevant to the questions and has two to
three grammatical or spelling errors.

2 points The answer is unclear and has four grammatical or

spelling errors.

1 point The answer does not address the question and has more than five
grammatical or spelling errors.

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 What I Can Do

Directions: Solve the problem below and answer the questions that follow. Write your
solution and answers on a separate sheet of paper.

Two investment proposals have been made and the following data are given below:
Year Project X Project Y
0 (Php 50,000.00) (Php 75,000.00)
1 Php 15,000.00 Php 24,000.00
2 Php 20,000.00 Php 24,000.00
3 Php 25,000.00 Php 24,000.00
4 Php 30,000.00 Php 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)

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 Assessment

Directions: Write T if the statement is correct and write F if the statement is incorrect.
Write your answers on a separate sheet of paper.
__ 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.

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 Additional Activities

Directions: Read and analyze the problem. Solve for the net present value of Projects
A and B and decide which project to accept. Write your answers on a
separate sheet of paper.

ABCD Company is considering two investment proposals. Both projects require

an initial outlay of Php 70,000.00. With Project A, the investment is estimated to
have an annual cash return of Php 62,000.00 for two years. With Project B, the
investment is estimated to have an annual cash return of Php 95,000.00 for one year
only. The cost of capital is 10%.
1. The net present value for Project A is:
A. Php 37,603.31 C. Php 27,603.31
B. Php 25,603.31 D. Php 17,603.31

2. The net present value for Project B is:

A. Php 29,363.64 C. Php 37,363.64
B. Php 11,363.64 D. Php 7,373.64

3. The investment proposal that should be accepted is/are:

A. Project A C. both projects
B. Project B D. none of the above

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