Capital Budgeting conceptual Queries conceptual, calculator, necessary, purposes, saying

ruchita

For the Equivalent Annuity Approach (EAA)

Schweser Book 2 Page184:

Using the TVM functions of the calculator, the NPV is entered in with a negative sign. Is there any conceptual significance in this ? There is a note saying this is purely for calculation purposes but in calculating the price of the Bond, the negative sign is apt since it is a "CASH OUTFLOW" necessary to RECEIVE the PMTS (+ sign) and the FV (+ sign)


SO why the negative NPV ? how do we treat the cash flows as coupons from a bond and live with it ??



Capital Rationing:


Schweser Book 2 Page185:

Can we use "Profitability Index" (PI) to select the projects

PI = 1 + NPV/Cash Outlay

and select the projects with the highest PIs ?

BelalM

When NPV is entered with a -ve Sign (esp to calculate the EAA stuff) - you end up with a positive EAA. If you entered it as a positive number - you would get -ve payments...

Yes PI can be used to select projects in a situation of Capital Rationing.

First make sure that the Capital Budget constraint has not been exceeded.
If two projects have identical NPVs - the PI acts as a tie-breaker.

CP

neil1234

Thanks for adding to the post.
Was confused about usage of PI.

DSquaredSlim

Thank you guys, never really expected such prompt help. Good luck & God bless.

PS: @ cpk I almost LoLd , just gotta keep it simple i guess.