Chapter 10: Fundamentals of Capital Budgeting

What is the payback period?

Why does the payback period provide a measure of a projects liquidity risk?

What are the main shortcomings of the payback method?

Net present value: Blanda Incorporated management is considering investing in two alternative production systems. The systems are mutually exclusive, and the cost of the new equipment and the resulting cash flows are shown in the accompanying table. If the firm uses a 9 percent discount rate for production system projects, in which system should the firm invest?

Year System 1 System 2

0 -15,000 -45,000

1 15,000 32,000

2 15,000 32,000

3 15,000 32,000

Payback: Northern Specialties just purchased inventory-management computer software at a cost of $1,645,276. Cost savings from the investment over the next six years will produce the following cash flow stream: $212,455, $292,333, $387,479, $516,345, $645,766, and $618,325. What is the payback period on this investment?

What are the five steps used in NPV analysis?