### 🔴 Capital Budgeting in 10 min., Capital Budgeting Techniques Decisions NPV Net Present Value

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**Chester McEachern** - 1 month ago
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Capital Budgeting Lecture in 10 min. Capital

Budgeting Techniques Decisions NPV Net Present Value Hello! Welcome back again to www.MBAbullshit.com.

Our topic for this video is Basic Capital Budgeting, alright? Remember, you can always

go back to www.MBAbullshit.com. But before we move on to this video, you should first

understand Present Value and Net Present Value. If you don’t know these two topics yet,

then I suggest that you first watch my other free videos on these two topics. Okay, so

let’s get right down to it. First of all, I’d like to answer the question

first. “What is Capital Budgeting?” Okay? When do we say we’re Capital Budgeting,

or whatever, in business school? Well, basically, it answers other questions, example you’re

thinking about doing a new project for your business. Capital Budgeting is when we ask

ourselves, “Is it worth it to put money or capital, also known as “capital” into

this project? Is it worth it? Is it a good decision? Is it a good deal in terms of money?

In terms of earning to put money in this new proposed project?

It could also mean, “Is it worth it to use money to buy new machine? Have you think about

how much this new machine will earn, compared to the cost of getting money to buy this machine.

Or, “Is it worth putting money in a new business as a whole?” Maybe you are thinking

of putting up a brand new whole business. Or maybe you are thinking of buying an existing

business. Is it worth it to put money in this business? Or pay money for this business?

As an example, let’s look at a valuing a project. This is just a simple example. Now

let’s say that you are thinking of borrowing one thousand dollars from the bank which charges

five percent interest rate so that you can buy a new machine for one thousand dollars.

Let’s pretend that this machine will earn you two hundred sixty dollars for two years.

And let’s say that you can only use it for two years because after two years, it’s

going to breakdown. But you can sell it for scrap at five hundred dollars in the end after

the two years. So my question is, “Will you win or will you lose money in this new

project or in this new machine?” It doesn’t matter if it’s a machine or a project or

both, okay? Will you win or lose money in this project?

Now, if you look at two hundred sixty dollars for two years that’s like five hundred twenty

dollars plus you earn five hundred dollars, you have one thousand twenty. One thousand

twenty is higher than one thousand dollars so maybe you think that you will earn money

from this project. However, it is not as simple as that. Because remember, the concept of

time value of money, future value of money and present value of money. So if you want

to find out, if this is a good deal or not, we should first find out the sum of the present

values of both the cash outflow and cash inflows. We first look at the present values of these.

When we do that, the formula as you remember from the present value formula, will look

something like this. Don’t panic. Where did we get this? This one thousand dollars

is just the same as the one thousand dollars that you are paying for the machine. This

point zero five is just the same as the five percent interest rate that you are paying

in the bank. This two hundred sixty dollars here is just the same as the two hundred sixty

dollars earnings that you’ll get and it happens for two years. This negative one is

the two hundred sixty dollars represents the going back one year to the present value of

the first two hundred sixty dollars and this negative two power over here represents the

two years; one, two that this two hundred sixty dollars will go back. So that we can

find out the present value and this five hundred dollars over here represents the five hundred

dollars you earned at the end of two years when you sell the whole machine. Alright?

Simple as that. But before we move on, I have a reminder:

In more advanced problems, we will use the WACC, the Weighted Average Cost of Capital,

instead of the bank interest rate in five percent, okay? But this is just a very simple

example so I’ll just use the bank interest rate. And also, in more advanced problems,

we will include other factors such as horizon value and growth rate, etc. Don’t worry

if you don’t understand these things right now because it is not needed for this basic

example or for this basic problem. So now we have this.

If we move on to the other slide, here it is, exactly the same. Remember, this negative

zero over here is because this negative one thousand dollars is the one thousand dollars

that you are paying today. If you are paying it today, you are bringing it back, not one

year but you are bringing it back zero years because it is today, alright? So, now if we

add this all up and multiply this all together, we will come up with this negative sixty three

dollars as the present value of this project, of this machine, after we borrowed money to

buy it and after we earned money from it. This means this project is worth a negative

sixty three dollars or you will lose sixty three dollars if you do this project. So therefore,

don’t do it. Okay? However, if it was a positive number then

in that case you would earn money. Therefore, you should do the project. But in our case

it’s negative so don’t do it, alright? So now you understand the basic concept so

you can move on to our next video, if you like, on Capital Budgeting: Valuing a Business.

Remember to share it if you like it on twitter, my name is @MBAbullshit. Or please share my

YouTube link on your Facebook or on your email to your friends. Goodbye and have a great

day. debbierojonan Page 1

you talk as though you are retarded. good concept the mbabullshit but hard to watch

it should flow.

@vertexclimber …that's because I **AM** retarded. LOL =p

@MBAbullshitDotCom I honestly remember writing this it's not like me to criticize, sorry.

@Judge4utube Thanks too dude! Remember to click "Like" and share it with your friends. Cheers!

@BarryManchurian Hello Barry. That's an interesting question; although I've never actually every seen it included in this capital budgeting formula, even if you google it. My "educated guess" is that this equation we used is already a shortcut version which already factors in the effect of interest; and that a longer version may include the interest payment and still come out with the same result. Anyone else care to comment?

@BarryManchurian (Cont. from earlier reply): Also note that I used the "borrow from bank" analogy just so that we'd have a basis for "required return". I do know that if the IRR for this project is less than the bank's interest rate, then we come up with a negative Present Value or Net Present Value for the project/machine… and if the IRR is higher than the bank interest rate, we come up with a positive Net Present Value.

this video is super………thanks

@MrGeneralRosh WOW, glad to know you got an A! The premium video purchasing is updated and a lot clearer now. Cheers!

@chait8 Good to hear that LOL!

good video my friend

helped me pass my b.com exam of financial management 😉

@KingBhatt55 Congratulations in passing your exam!

thanks for all the great videos, i've watched several of them so far and they've helped me more than my finance professor & textbook ever did!

by the way, when i used my financial calc. in calculating the NPV, i got a different answer than you. i inputted:

CF0 = -1000

CF1=260

CF2=260

CF3=500

N=2

I=5

so my result is NPV=-84.63. will you be able to point out where exactly i went wrong in my calculations?

thank you for your time!

Hi Comeoutside. I don't know exactly how your particular financial calculator works, but keep in mind that cashflow2 (260) and cashflow3(500) come at the same time… try using your calculator again but inputting both the 260 and 500 as just one item (760)

awesome, that did the trick!! thank you so much for the super quick response!! ^_^

Great to hear that and good luck!

Thanks for the easy to understand vids! One thing has caught me out though – Should this project have cost even more, factoring the interest from the bank (FV of loan after 2 years $1,102.50) or am I missing something? Thanks for your time 🙂

Hi! Check out my earlier reply to poster named BarryManchurian. Cheers!

An interesting lecture!!!!!!!!!!!!!

Thanks Shahin!

I understand using the 0.05 in the PV calculation for the $1,000, since you have to pay interest on this. But why use the 0.05 for the $250 and $500, since you are not paying the 5% interest on these?

Yes, I did watch the previous videos on OV and FV.

Thnx.

Haha, it's awesome how you say "okay don't panic" right when I start panicking.

Haha, well, 'don't panic!'

@nadeesha: I think like should really be simple 🙂

You are amazing! Thank you for doing this! It is easy to understand! 🙂

@Linda wow! great to be called amazing!

That is really easy to catch, thanks man!!!

@Aidan glad you 'caught' it! 🙂

@Swapnil Thank youuuuuu

i dont understand( 1.05) where it comes from

@Rado the formula is to add 1 + the given interest rate. The given interest rate here is 5% or 0.05. So 1 + 0.05 is 1.05

great thanks.

@MD you're welcome.

vey helpfull. keep i tup

thanks

getting through the bullshit thanks to MBABULLSHIT.COM. I love MBABullshit.com! 🙂

Very good video . I like the way you described in a simple and lucid way.Thanks for the video.

Hi, Can you please share the working of that equation. I am getting a a variance in the figures.

Thanks

Thanks for the video. It helps me understand about the basic of capital budgeting.

Thanks for explaining. A question:

Not looking at the NPV, if we calculate 5% of $1,000 for two years, the total would be $1,097.5 – thats the total you'll pay to the bank after 5% interest in 2 years (1000+50+47.5). Now, machine will earn $260 for 2 years i.e. $520 in total and we can sell it for $500 scrap i.e. $1,020. So, $1,020 (inflow) – $1,097.5 (outflow) = -$77.5. How is this wrong?

hello m sameer .i need full ou mba clases of all subjectsonline in mbabullshitdotcom .will this workout or not .please reply

great explaination

I saw so many videos but your videos are best. I watched all your videos. Thank you very much

God bless you !!

Fantastic explanation

Amazing 🙂 but this 1000 we borrowed from the bank, when r we supposed to pay it back ?

"dont worry, dont panic" keeps me motivated to study longer..

nice

awesome man. thx

Bullshit!!!! But thankyou man. Really

hi there:) how do i find your videos on all the intermediate accounting

Best explanations! In my 3rd year in Finance and started watching your vids in 1st year, keep it up!

Best explanations! In my 3rd year in Finance and started watching your vids in 1st year, keep it up!

What a mind-catching presentation as well as explanation in an organized fashion.Really like & love it!!!

thanks from Middle East

As a Finance major student, i can tell u that it is very helpful for beginner.

it is really helpful dear. tq alot

love the presentation

Why do you not subtract the interest rate of 5% or 50 in dollar terms from the cashflows? When you say "it will earn 260" it sounds like you mean the project itself, not included outside factors such as financing. Just to clarify the 260 is already included the interest costs?

lol man why with the foul language? Revise your site to www.MBAbull.com. Thnx man

Use the below formula..its more easier…

YEAR CASH FLOW NPV INT

0 (1,000.00) (1,000.00) 5%

1 260.00 247.62

2 760.00 689.34

3 – – 936.96

Total (63.04)

NPV (63.04)

IRR 1.14193%

YEAR CASH FLOW NPV INT

0 -1000 =G6/(1+$I$6)^F6 0.05

1 260 =G7/(1+$I$6)^F7

2 =260+500 =G8/(1+$I$6)^F8

3 0 =G9/(1+$I$6)^F9 =H7+H8

Total =SUM(H6:H9)

NPV =G6+NPV(I6,G7:G9)

IRR =IRR(G6:G9,I6)

Hello Sir..Plz listen I am.not understand about _63 dollars ans that how is it come so kindly plz solve it step by step….Thanks Sir I will wait…

Brilliant!

Thanks for the info. Can you confirm that the method you used in valuation is the "Discounted Cash flow method"?

you explain much clear than my professor. thank you I subscribed you and will watch all your videos

thaanksss dudee

i. Calculate the value of the project below and what recommendation would you make relative to implementation of the project? Why?

Venezia Manufacturing is spending RM 115,000 to update its equipment. This is necessary if the firm wishes to be competitive in the marketplace and provide a wide array of product models. The company estimates that these updates will improve its cash inflows by RM 27,500 a year for four years. The company requires a 14 percent return on the investment.

Thanks, nicely explained

thank you! all the love from the philippines 💕

Thank you for good explanation, but I wonder the example doesn't include interest payout?

Good presentation bro thanks.

Isn't it supposed to be Npv rather than pv?

Since the actual payback of the $1,000 loan isn't until 2 years, shouldn't that payment be discounted for 2 years? Your actual cash outlay in year 1 is only the interest payment, right?

Very good explanation

Awesome! Keep it up

wonderful class with simple example…thank you so much

When the formula comes up, i actually panic and about to quit this video, then you say "don't panic" :)))))))))))))))). That really helps, thanks.

Indeed the presentation is awesome but um little bit confused when coming to the last year of the selling of the scrap machine. i was hoping to have that time of negative two to be negative three,could anyone help please fellow followers

You are awesome thanks for ur great help sir.. 😍