**STEP 2 – Basic Capital Budget Analysis**

**As the manager of the pension fund, you are frequently targeted by software companies peddling investment simulation software. ** **You have finally narrowed down your choice to two applications. ** **You need to analyze the options by calculating NPV, IRR and Payback Period based on their purchase price and savings to your company over time. ** **Your staff has prepared a cash-flow table to help you. ** **Year zero shows the purchase price of each application, and the figures listed for years 1-3 represent the savings to the company in successive years.**

**Year**

**Application I**

**Application II**

0 (today)

-$1.5 million

-$1 million

1

$0.8 million

$0.5 million

2

$0.7 million

$0.24 million

3

$0.3 million

$0.6 million

You are considering three possible scenarios.

**Question 7:** If the payback period is two years, which application should be selected?

**Question 8:** If the required rate of return is 15 percent, which application should be selected?

**Question 9:** If the selection criterion is IRR, which application should be selected?

**Respond to the questions 7, 8, and 9 above by submitting a single, integrated report that shows your supporting data and calculations. Finally, provide a recommendation and rationale for purchasing either Application I or Application II. **

**Be sure to show your calculations in Excel and provide a narrative analysis in Excel.** Your narrative analysis should include your recommendation and rationale for purchasing either Application I or Application II.

**Before you submit your assignment, review the competencies below, which your instructor will use to evaluate your work. **A good practice would be to use each competency as a self-check to confirm you have incorporated all of them in your work.

- 3.1 Identify numerical or mathematical information that is relevant in a problem or situation.
- 3.2 Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.
- 3.3 Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.
- 3.4 Employ software applications and analytic tools to analyze, visualize, and present data to inform decision-making.
- 10.3 Determine optimal financial decisions in pursuit of an organization's goals.
- 10.4 Make strategic managerial decisions for obtaining capital required for achieving organizational goals.

**Additional Guidance on Project 4**

**Ques 7.** Payback period — how long will it take to recoup the initial investment. If $X invested today, given expected cash inflow over time — the question becomes, how long will it take to recoup the initial investment $X. Be sure calculate the precise period of time, which often times is a mixed number like 2 1/2 years.

**Ques 8.** Run the NPV in Excel for each option and determine which option is better. Use = NPV(………) and Excel will display the requirements. Note that Year 0 is already in present value format so do not include Year 0 in your PV cash flow range. However, you will need to deduct the initial investment from the PV of future cash flows, like = NPV(CF1….CFN) – Initial Investment.

**Ques 9.** For IRR calculation, use =IRR(CF0…CFN), include the entire cash flow stream.