Sensitivity Analysis in Capital Budgeting

Definition Sensitivity analysis is used to evaluate how sensitive the output variable is to the change in one of the variables while other input variables remain unchanged. Sensitivity analysis is widely used in capital budgeting… Read more

Inflation and Capital Budgeting Analysis

Inflation affects capital budgeting analysis. It drives an increase in both revenue and costs, affecting future cash flows of a project. Inflation is also one of the components of interest rates, i.e., it is already… Read more

Capital Rationing

Definition Capital rationing is a technique used in capital budgeting that helps select the most profitable capital projects when the ability of a company to raise additional capital is limited, and a company sets a… Read more

Equivalent Annual Annuity

Definition The equivalent annual annuity (EAA) method is used in capital budgeting to rank mutually exclusive projects with unequal life spans. The concept is based on assuming that a project is an ordinary annuity with… Read more

Replacement Chain Method

Definition The replacement chain method is used in capital budgeting to rank mutually exclusive projects with unequal life spans. As the first step, it is necessary to determine the minimum common multiple life span for… Read more

Profitability Index, PI

Definition The profitability index (PI) is one of the methods used in capital budgeting for project valuation. In itself it is a modification of the net present value (NPV) method. The difference between them is… Read more

NPV vs IRR Method

Problem The net present value (NPV) and internal rate of return (IRR) methods are based on the same discounted cash flows technique, hence they take into account the time value of money concept. Furthermore, both… Read more

Net Present Value, NPV

Definition The net present value (NPV) method is widely used in capital budgeting and investment decisions. It is also considered as the best single screening criterion to reject or accept a project because the NPV… Read more

Modified Internal Rate of Return, MIRR

Definition The modified internal rate of return (MIRR) is a modification of the internal rate of return (IRR) and is used in capital budgeting as a ranking criterion for mutually exclusive projects. The idea behind… Read more

Multiple IRR Problem

Definition The multiple internal rates of return problem occur when at least one future cash inflow of a project is followed by cash outflow. In other words, there is at least one negative value after… Read more