Chapter 8
Capital Budgeting
Go to the Chapter 8 folder in the Additional Instructor Resources & Solutions folder to
find the Excel spreadsheets and other resources that accompany this chapter’s material.
Chapter Overview
I. Introduction
II. Defining capital budgeting
a. What is capital?
d. Current expenditure
III. The process of capital budgeting
a. Determine the initial cost of the project
b. Determine the incremental cash flow of a project
c. Select the capital budgeting method
i. Payback period
1. Single-project payback period calculation
method
ii. Discounted payback period
1. Single-project discounted payback period calculation
iii. Net present value
1. Two-project NPV calculation
iv. Internal rate of return
v. Modified internal rate of return
1. Terminal value
d. Conduct a post-audit analysis
IV. Conclusion
Key Concepts
When reading this chapter, students should focus on the following key concepts:
1. Capital budgeting is used to analyze an organization’s capital expenditures.
2. Five capital budgeting methods can be used to analyze capital projects; each one
provides relevant information useful to management when selecting a project
for inclusion in the organization’s capital budget.
Concept Check Responses
1. What is capital budgeting?
Capital budgeting is the process of evaluating, comparing, and selecting capital
2. What major information (data) do you need for capital budgeting when you
want to compare projects?
First, you need to calculate the initial cost of the project. Here you will need
the project’s invoice price, adjustments made to the price, discounts made on
3. What relevant information is provided with each capital budgeting method?
• Payback Period—indicates the length of time the firm’s funds will be
tied up in a project (the project’s liquidity)
4. What is the problem with multiple IRRs, and when in sport would they occur?
Multiple IRRs indicate different rates of profitability for a project. To make a
wise decision, one must ensure that the IRR is greater than the cost of capital.
5. In sport, which method of capital budgeting is superior? Why?
MIRR is preferred to IRR because non-normal cash flow is prevalent in the
6. What is the purpose of the post audit in the capital budgeting process?
The purpose is to compare the project’s actual results to the predicted results
Responses to Practice Problems
Note: The solutions to Problems 1–5 and 7 are in the Additional Instructor Resources
& Solutions folder for Chapter 8 “Practice Problem Solutions.”
1. Project M has a cost of $65,125, expected net cash inflows are $13,000 per
year for 10 years, and a cost of capital of 11%. What is the project’s payback
period (to the closest year)?
2. Refer to Problem 1. What is the project’s NPV?
MIRR are greater than the 11% cost of capital.
7. Your division is considering two facility investment projects, each of which
requires an up-front expenditure of $15 million. You estimate that the
investments will produce the following net cash flows:
Year
Project A
Project B
Responses to Case Analysis Questions
Note: This problem is essentially a capstone problem for the first eight chapters of
the textbook. Answers will vary widely. Two solution files from a similar version of
this assignment were completed by students in a 400-level class and are included
here. For each solution, there is a Word file and an Excel file, found in the Additional
Instructors Resources & Solutions folder.
1. Based on the facts presented, does this project “make sense”? Be sure to
calculate NPV, IRR or MIRR when answering this question. Assume a 30-year
useful life for the facility.
2. Based on your analysis in Question 1, would you recommend any changes to
the proposed venue? Why or why not?
Changes likely will be recommended based on the pure capital budgeting
3. Based on your answers in questions 1 and 2, why do you think the city built the
pool (which opened in 2018)?
Additional Classroom/Exam Problems
Note: The solution to this problem is in the Additional Problems Solution File, found
in the Additional Instructors Resources & Solutions folder.
You are the financial analyst for the University of South Carolina’s athletic
$15,000,000, and the cost of capital is 8.75%. The project’s expected net cash flows
are as follows:
a. In Excel, calculate each project’s payback period and discounted payback
period.
b. Using Excel’s financial functions, calculate each project’s net present value,
internal rate of return, and modified internal rate of return.