Developing Operating &

Capital Budgeting

Instructor : Ali Kabiri

 Budgeting
The process of planning future business actins and expressing
those plans in a formal quantitative and monetary terms or
statement is called Budgeting .

Budget
A budget is a quantitative expression of plans. It is used
commonly by:
 Business Firms
 Government Agencies
 Non-Profit organizations
 Households

How Budgets are useful?

 Induce management to think systematically
 Swerve as a device for coordinating the complex operations
of business.
 Provide a medium for communicating the plans of the firm
 Motivate managers at all levels to perform well.
 Serve as a standard against which the actual performance
may be judged.
 Framework for Budgeting
 Strategy, Planning and Budgeting: The exercise of
periodic budgeting is based on the framework of corporate
strategy and long–range plan. The corporate strategy of the
firm reflects its basic objectives and the fundamental policies
for realizing these objectives. The long-range plan of the firm-
founded on its corporate strategy-delineates its major
programs in various areas (production, marketing, finance,
research and development, human resources, and etc.) ,
expected revenue and expenses, and projected financial
conditions over the next few years.

When the corporate strategy and long-range plan are not

explicitly articulated, the top management may specify certain
broad guidelines at the time of budget preparation. Such guide
lines would reflect the corporate strategy and long-range plan
followed implicitly by the top management. A simple guideline
may be: “Assume that volume would increase by 5% and
prices and cost would increase by 10% next year.”
 The Budget period: In order to be operationally
meaningful, the budget must be drawn up for a specific
time period. Usually, the budgets drawn up for a year. The
yearly budget may be divided into quarterly or even
monthly budgets. Generally, the budget may be divided
into two parts with differing levels of detail applying to
them. For example, the budget for the first quarter or first
six months may be drawn up on a monthly basis and for the
remaining period on a quarterly basis where further it may
then be cast in terms of monthly budgets.

Some firms employ a rolling budget, under this system, at

the end of each quarter or each half year, the budget is
extended by adding another quarter or another half year.
Hence the firm always has the budget for a year ahead of
it.
 Program Budget and Responsibility Budget: The
operating budget for the firm may be constructed in terms
of program (program budget) or responsibility areas
(responsibility budget).
The Program budget is developed in terms of products that
are regarded as the principal program of the business. Such
a budget shows the expected revenues and costs of various
products (direct and indirect costs).

The Responsibility budget shows the plan in terms of person

responsible for the achieving them. To illustrate, an
organization may be divided into several departments
(responsible center) and a budget is drawn up for each
department showing what costs are amenable to control by
the departmental head (head of responsible center).
 Organization for Budgeting
Though there seems to be no standardized organization for
budget preparation, in most of the large firms which
develop formal budgets, a basic pattern exists. There is a
budget committee and a budget director which guide and
monitor the process of budgeting. In this, understandably,
the line executive have a significant involvement.
Consisting of several top management executive, the
budget committee:

* Sets broad guidelines for budgeting

* Coordinates the separate budgets prepared by different departments
* Reconciles inconsistencies among various departmental budget
* Compiles the budget in its final form
* Sends the budget for the approval of the chief executive and the board of
director
 Limiting Factor
In every firm, there is a critical factor which sets a limit to
its level of activity. Often, the expected demand is limiting
factor which defines the scope and level of operations.
When the demand is fairly strong, the limiting factor may
be the production capacity of the firm which can not be
augmented in the short run, or it may be availability of man
power or raw material if the firm is located in a man power
or raw material deficit region and finally, for the firms which
do not have easy access to the capital market, finance may
be a limiting factor.
Since it determines the scope and level of operations, the
limiting factor is the most appropriate starting point for the
budgeting exercise. For example, it make no sense to begin
planning with production capacity when the limiting factor
is the expected demand.
 Participation
The budget guidelines prepared by the budget committee
are transmitted down the organizational hierarchy. At each
level, the management may provide more detailed
information for guiding its subordinates till the guidelines
reach the level of supervisors who head the lowest level of
responsibility centers. Each supervisor prepares budget
estimates of items of expense controllable at his level.
Expense items not controllable at his level are usually
added later by the budget staff. The budget prepared by
the supervisor serve as the starting point for the
negotiation between the supervisor and his superior.
 Master Budget
When the plan to be formalized is comprehensive or
overall plan for the business, the resulting budget is
called Master Budget. Comprehensive in scope, the
Master Budget covers all facets of the operation and
finances of the firm.

A Master Budget has four major components:

4. Operating Budget
5. Capital Expenditure Budget
6. Cash Budget
7. Projected Financial Position.

The inter- relationship among these budgets and their

principal parts is shown in the below Figure.
 Components of a Master Budgeting System

Sources and Uses of Funds

Operating Budget Cash Budget Projected Balance Sheet
Statement

Capital Budgeting Investment and Financing

Sales Budget
Expenditure Budget

Production Budget

Material &
Purchase Budget

Labor Cost Budget

Manufacturing
Overhead Budget
Non-Manufacturing
Cost Budget
 Typical Master Budget
1. Operating Budget
a) For Merchandizing Companies: Merchandize Purchase
Budget
b) For Manufacturing Companies:
* Production Budget
* Manufacturing Budget
c) Selling Expenses Budget – Non Manufacturing cost
Budget
d) General and Administrative Expense Budget

2. Capital Expenditure Budget

3. Financial Budgets
* Cash Budget: Budgeted statement of cash and
disbursements
* Budgeted Balance sheet – Projected Balance Sheet
* Budgeted Income Statement
 Master Budget Preparation
Sequences
Preparation of Budgets within the Master Budget
must follow a definite sequence, as follow:
2. The sales budget must be prepared first
because the other sub units of operating budget
such as; production budget, materials and
purchase budget and etc. is depend upon
information provided by the sales budget.
3. In the next step, the remaining operating
budgets are prepared.
4. In this stage Capital expenditure budget is
prepared. This budget usually depends upon
long-term sales forecasts more than it does
upon the sales budget for the next year (Short-
term).
1. Based upon the information provided in the above
budgets, the budgeted statement of cash receipts
and disbursements is prepared. If this budget
discloses an imbalance between disbursements and
planned receipts, the previous plans may have to be
revised.
2. The budgeted income statement is prepared next. If
the plans contained in the master budget results in
unsatisfactory profits, the entire Master Budget may
be revised to incorporate any corrective measures
available to the firm.
3. The budgeted balance sheet statement for the end
of the budgeted period is prepared last. An analysis
of this statement may also lead to revisions in the
previous budgets. For examples, the budgeted
balance sheet statement may disclose too much
debt resulting from an overly ambitious expenditures
budget, and revised plans may be necessary.
 Operating Budget

 Sales Budget
 Production Budget

 Material and Purchases Budget

 Labor cost Budget

 Manufacturing Overhead Budget

 Non-Manufacturing cost Budget

 Sales Budget
The sales budget provides an estimate of goods to be sold and
revenue to be derived from sales.

The Sales forecast or budget for the forthcoming (budget)

year is usually the starting point of the budgetary exercise.
Production, materials, labor, etc., are related to the level of
sales.

The sales budget commonly grows from a reconciliation of

forecasted business conditions, plant capacity proposed
selling expenses such as advertising and estimates of sales.

In preparing the sales forecast, the following factors should be

considered:
 The outlook of the industry and economy
 Past behavior and emerging trends in sales
 Governmental regulations and controls affecting the
industry
 Consumer attitudes, dispositions, tastes, and preferences
 The nature and the extent of competition
 Northern Company
Monthly Sales Budget
September 2006 –January 2007

Months Budgete Budgete Budgeted Total

d unit d unit Sales
September Sales
7,000 Price
$10 70,000

October 10,000 $10 100,000

November 8,000 $10 80,000

December 14,000 $10 140,000

January 9,000 $10 90,000

 Production Budget
In manufacturing organization, the budget of production
is one of the operating budget. A well balanced
production plan is required to ensure economical
manufacturing. The factors that influence t6he plan
of production are:
ii. The volume and timing of sales
iii. Inventory of sales and
iv. Productive capacity

The production plan geared to meet the requirement of

sales. Goods flow from production line largely is in
conformity with the needs of sales. There may ,
however be significant divergence between the
pattern of sales and pattern of production. This
happens under two conditions:
vii. There is a pronounced seasonal variation in sales
whereas production is planned in a stable manner.
viii. Production necessarily has to be carried out during
a certain period of the year, whereas sales occur
The steps involved in preparing the production
budget are broadly as follows:
 Assess the productive capacity of the firm
 Specify the finished goods inventory policy of the
firm
 Estimate the total quantity of each product to be
manufactured during the budget period on the
basis of sales forecast and finished goods
inventory policy
 Schedule the production during the budget
period, taking into account the pattern of sales,
the finished goods inventory policy, and the
productive capacity
 Material and Purchases Budget
Once the production budget defines the quantity to be
produced, the next logical step is to estimate the material
requirements and determine the purchase program. In
this context, the following principal budgets are
developed.

Material Budget: Materials used in a manufacturing unit are

traditionally classified as Direct and Indirect. Direct
materials are materials which arte directly identified with
the product and are visibly incorporated init. Indirect
materials cannot be traced directly to the product. The
material budget generally is concerned only with Direct
materials. Indirect materials and supplies are covered by
the manufacturing Overhead budget. The material
budget shows the quantities, and often the prices, of
materials planned to be purchased.

Purchase Budget: This budget shows:

f) The quantities of each type of raw material to be
purchased,
g) The schedule of purchases, and
h) The estimated cost of purchases.
In developing the purchase budget, one has to take into
account the following:
ii. The quantities specified in the materials budget
iii. The planned changes in material inventories
iv. Re-order levels of various inventory items, and
v. Economic order quantities of various inventory items.

Budgeted sales for the month XXXX

Add the budgeted end of the month inventory XXXX
Required amount of available merchandise XXXX
Deduct the beginning of month inventory (XXXX)
Inventory to be purchased XXXX
 Northern Company
Merchandise Purchase Budget
September, October, November 2006

Sep Oct Nov

Next month’s budgeted sales (In units) 8,000 14,000
9,000
Ratio of inventory to future sales x90% x90%
x90%
Desired end of month inventory 7,200 12,600
8,100
Budgeted sales for the month (In units) 10,000 8,000
14,000
Required units of available merchandise 17,200 20,600
22,100
Deduct beginning of month inventory (9,000) (7,200)
(12,600)
Number of units to be purchased 8,200 13,400
9,500
Budgeted cost per unit x$6 x$7
x$8
Budgeted cost of merchandise purchases $49,200 $80,400
$57,000
 Labor cost Budget
Labor Cost Budget: Labor is generally classified as Direct and
Indirect. Direct labor cost represents the Wages paid to workers
employed directly in the manufacturing activity. Indirect labor
cost represents all other labor costs , such as supervisory
salaries, wages paid to storekeepers, maintenance personnel,
janitors, etc. The budget for labor cost normally includes the
cost of direct labor only. The following approaches may be used
for developing the labor cost budget:

3. Labor cost per unit of production = (Standard direct labor hours

required for each unit of production) x (Average Wage rate per hour)
4. Labor cost Budget = labor cost per unit x Number of units of finished
goods planned

When the above approaches cannot be used, the labor cost budget
may be developed on the basis of information about:
vii. Permanent manpower employed in direct manufacturing
activity and their remuneration rates
viii. Payments likely to arise on account of overtime work
ix. Temporary manpower that may be needed and their
 Manufacturing Overhead
Budget
Manufacturing overhead is that part of factory cost which
is not included in direct material and direct labor
cost. Not directly identifiable with specific products
or jobs, manufacturing overhead consists of:
ii. Indirect material
iii. Indirect labor
iv. Miscellaneous factory expense items, such as
depreciation, utilities, supplies, repairs,
maintenance, insurance, tax, and etc.

To construct the manufacturing overhead budget,

expense budgets for all the departments in the
factory – production as well as service departments
– have to be drawn up and aggregated. For this
purpose, the expected volume of the work to be
done in each department has to be determined in
terms of an indicator appropriate to its activity.
Some measures of activity are given below:
 For producing departments
* units of output
* Direct labor hours
* Direct machine hours

6. For service departments

* Repair and maintenance: direct repair hours or the
number of machines to be maintained.
* Purchase department: total purchases in monetary term
or the purchases order to be placed.
* General factory administration: number of employees in
the plant or total direct labor hours.

Given the activity level of each department in terms of a

suitable measure, departmental budgets are drawn up in
terms of two basic components: the variable cost (the
cost that changes as the level of output changes) and
fixed cost (the cost that remains constant as the level of
output changes).
 Non-Manufacturing Cost
Budget
Non manufacturing costs consists of expenses for selling and
distribution, general administration, research and
development, and financing.

The budgets for non manufacturing cost are normally

prepared along departmental lines. For each non
manufacturing department the budget may be developed
as the budget for manufacturing overhead is constructed.

For example the responsibility for preparing a budget of

selling and distribution expenses typically falls on the vice
president of Marketing or equivalent Sales manager. In this
case, although budgeted selling expenses should affect the
expected amount of sales, the typical procedure is to
prepare a sales budget first and then to budget selling and
distribution expenses budget.
 Capital Expenditure Budget
The capital expenditure budget shows the list of capital
projects selected for investment along with their
estimated cost. The capital expenditure budget or plant
and equipment budget lists equipment/s to be scrapped
and additional equipment/s to be purchased if the
proposed production program is to be carried out.

The proposals in the capital expenditure budget have to

suitably justified. Usually the justification is in terms of
quantitative criteria, such as the Payback Period (PBP),
Accounting Rate of Return (ARR), Internal Rate of Return
(IRR), Cost reduction per unit, productivity and etc.

There are qualitative criteria that needs to be taken to

consideration such as; growth opportunity, market
image, technological competence, morale, employee
safety, and etc.
 Cash Budget
The cash budget shows the cash inflows and outflows
expected in the budget period.

The major sources of cash inflow are: cash sales,

collection of accounts receivable, dividend and interest
income, disposal of fixed assets, long term and short term
borrowing, and raising of equity capital.

The major sources of cash outflow are: cash purchase,

payments of accounts payable, payments toward wages,
salaries, rent, utilities, and other operating expenses, tax
payment, purchase of capital assets, and repayment of
borrowings.

The preparation of the cash budget has its starting point in the
operating budget of the firm. The revenue and expenses
shown in the operating budget have to be translated into
cash inflows and cash outflows. In this context, the
following points may be mentioned:
i. The pattern of collection of accounts receivable (arise
from credit sales) is estimated by applying a suitable
“Lag” scheme. For example, it may be assumed that
40% of a month’s sales will be collected after one
month, 50% after two months and 10% after three
months.
ii. The cash disbursement or credit purchase may also be
estimated on the basis of a “Lag” factor.
iii. Operating expenses in terms of wages, salaries, rents,
etc. are assumed to have been paid in the month in
which they are incurred.
iv. Depreciation and other Non cash charges are not
included in the cash budget.

Apart from the operating budget, other influences on the

cash budget are: proposed acquisition and disposal of
capital assets, anticipated borrowing and their
repayments, proposed tax and dividend payments,
planned issues of equity and debt capital.
 Northern Company
Cash Budget
September ,October, November 2006

September November December

Beginning cash balance $20,000 $20,000 $22,272
Cash receipt from customers 82,000 92,000 104,000
Totals 102,000 112,000
126,000

Cash disbursements:
Payments for merchandise 58,200 49,200 80,400
Sales commission 10,000 7,900 14,000
Salaries 2,000 2,100 2,000
Administration 4,500 4,600 4,500
Accrued income taxes payable 20,000 - -
Dividend payable - 2,900 -
Interest on loans from bank 100 228 -
Purchase of equipments - - 25,000
Total cash disbursements 94,800 66,928
125,900

Balance 7,200 45,072 372

Additional loan from bank 12,800 - 19,628
Repayment of loan from bank - (22,800) -
Ending cash balance 20,000 22,272 20,000
 Projected Balance Sheet
The projected Balance Sheet shows
projected assets, liabilities, and owner’s
equity at the end of the budgeted period.

The inputs required for its preparation are

the initial balance sheet, the profit plan,
the capital expenditure budget, the cash
budget, and the investment and financing
budget.
 Northern Company
Budgeted Balance Sheet, 31st December 2006

Assets
Cash $ 20,000
Accounts receivable 84,000
Inventory 48,600
Equipments 225,000
Less accumulated depreciation 40,500 184,500

Total Assets
337,100

Liabilities and stock holders Equity

Liabilities:
Accounts payable 57,000
Accrued income tax payable 28,669
Bank loan payable 19,628 105,297

Stock holders’ Equity:

Common stock 150,000
Retained earnings 81,803 231,803

Total Liabilities and stock holders equity

337,100
 Capital Budgeting
Planning plant asset investments is called
Capital Budgeting. The plans may involve
new building, new machinery, or whole
new projects. In all such cases, a
fundamental objective of business firm is
to earn a satisfactory return on the
invested funds.

Capital budgeting involves the preparation

of cost and revenue estimates for all
proposed projects, an examination ofr the
merits of each, and a choice of those
worthy of investment.
Capital investments, representing the growing edge of a business,
are deemed to be very important for three inter-related
reasons:
2. They have long-term consequences. Capital investment
decisions have considerable impact on what the firm can do
in future.
3. It is difficult to reverse capital investment decisions because
the market for used a firm are tailored to meet its specific
requirements.
4. Capital investment decisions involve substantial outlays.

This section discusses the basics of capital budgeting. It is

divided into ten sub-sections as follows:
• Capital budgeting process
• Cost and Benefits Analysis: Basic principles
• Cost and Benefits Analysis: Illustrations
• Appraisal criteria
• Payback period (PBP)
• Average Rate of Return (ARR)
• Net Present Value (NPV)
• Benefit Cost Ratio (BCR)
• Internal Rate of Return (IRR)
Capital budgeting process
Capital budgeting is a complex process which
may be divided into the following phases:
3. Identification of potential investment
opportunities
4. Assembling of proposed investment
*Replacement investments
* Expansion investments
* New product investments
* Obligatory and welfare investments
9. Decision Making
10. Preparation of Capital Budget and
Appropriation
11. Implementation
* Adequate and detailed formulation of projects
* Use of the principle of responsibility accounting
* Use of Network techniques for monitoring the
Costs and benefits: Basic Principles
Once an investment project is proposed, its costs and benefits
must be estimated. In evaluating a capital expenditure
proposal, two broad phases are involved:
 Defining the stream of Costs and Benefits associated with
the investment.
* Cash Flow Principle
* Incremental Principle
* Long-Term Funds Principle
* Interest Exclusion Principle
* Post-Tax Principle

 Appraising the stream of Costs and Benefits associated

with the investment.
* Payback Period
* Average Rate of Return
* Net Present Value
* Benefit Cost Ratio
* Internal Rate of Return
 Cash Flow Principle: Cost and benefits
must be measured in terms of cash flows-
costs are cash outflows and benefits are
cash inflows.
 Incremental Principle: Cash flows must be
measured in incremental terms. This
means that the changes in the cash flows
of the firm which can be attributed to the
proposed project alone are relevant. In
estimating the incremental cash flows of a
project, the following points must be borne
in mind:
* Consider all incidental effects
* Ignore sunk cost
* Include opportunity cost
* Allocation of overhead cost
Appraisal Criteria:
Once the stream of costs and benefits of an investment project is
defined, the next logical question to ask is: Is the investment project
worthwhile? A wide range of criteria has been suggested to judge
worthwhileness of an investment project. The important investment
appraisal criteria, classified as follow:

APPRAISAL TECHNIQUES

Appraisal Criteria

Non – Discounting Factor Criteria

Discounting Factor Criteria (DCF)
(NDCF)

Pay Back Period Accounting Rate of Return Net Present Value Internal Rate of Return Cost Benefit Ratio
(PBP) (ARR) (NPV) (IRR) (CBR)
A. Non - Discounted Cash Flow (NDCF)
This method of investment appraisal does not take into
consideration interest rate and Time that is time value of
money.
1. Payback Period (PBP)
The payback period is the length of time required to recover
the initial cash outlay on the project.
0 year 1st year 2nd year 3rd 4th year
year
Income (500) 150 200 350 400

Operating Costs 0 50 50 50 50

Net income Flow (500) 100 150 300 350

Accumulated (500) (400) (250) 50 400

income
2. Average Rate of Return (ARR)
The average rate of return, also called the
accounting rate of return is defined as a method
that measures the net return each year as a
percentage of the initial cost of the investment.

ARR =Net Return (profit) per annum / Capital outlay X 100

 Project Project Project
“X” “Y” “Z”
Cost (Capital outlay) (50,000) (40,000( (90,000)

Return year 1 10,000 10,000 20,000

Return year 2 10,000 10,000 20,000

Return year 3 15,000 10,000 30,000

Return year 4 15,000 15,000 30,000

Return year 5 20,000 15,000 30,000

Total Return 70,000 60,000 130,000

Total Net Return 20,000 20,000 40,000

Net profit / annum ) 5 4000 4000 8000

years)

Average Rate of 8% 10% 8.9%

Return
B. Discounted Cash Flow (DCF)
This method of investment appraisal has certain advantages, it deals
with the problems of interest rate and time, that is time value of
money which is ignored under Non- discounted factor appraisal
technique.

Discounted cash flow takes into account that interest rates affect the
present value of future income. It shows that the future cash flow
is discounted by the rate of interest.

The return on an investment project is always in the future, usually

over a period of several years. Money earned or paid in the future
is worth less today.

Present Value = A / (1+r (ⁿ

Where:
A = Amount of Money
R = Rate of interest
n = Number of years
Net Present Value (NPV):
The Net Present Value (NPV) of a project is equal to the sum of
the present value of all the cash flows associated with the
project. Symbolically:

NPV = CF0 / (1+k)ⁿ + CF1 / (1+k)ⁿ + CF2 / (1+k)ⁿ + CFn / (1+k)ⁿ

+……

Where:
NPV = Net Present Value
CF = Cash flow occurring at the end of year “ n ” (0, 1, 2, 3, ….
n)
n = Life of the project
K = Discounted rate
 Year 0 1 2 3 4 5

Cash flow (10,000,00 2,000,000 2,000,000 5,000,000 6,000,00 6,500,000

0) 0
Discount Rate 0% 10% 10% 10% 10% 10%
(10%)
Discounted Factor 1 0.9 0.81 0.729 0.656 0.591

Discounted Cash (10,000,00 1,800,000 1,620,000 3,645,000 3,936,00 3,841,500

Flow 0) 0
Accumulated
Discounted Cash (10,000,000 (8,200,000 (6,580,000 (2,935,000) 100,1000 4,842,500
Flow ) ) )

NPV = Total present value – Initial outlay

A project with the higher NPV value will be

chosen as a selected project.
Internal Rate of Return:
The internal Rate of Return of a project is the discount rate at
which makes its net present value equal to zero.

0=CF0 / (1+r)0 + CF1 / (1+r)1 + CF2 / (1+r)2 +………+ CF n / (1+r)n

CF = Cash Flow at the end of year

r = Discount Rate
n = Life of the Project

In the Net Present Value (NPV) calculation we assume that

the discount rate (Cost of Capital) is known and we
determine the Net Present Value of the project.

In the Internal Rate of Return (IRR) calculation, we set the

net present value equal to “ZERO” and determine the
discount rate (Internal Rate of Return) which satisfies this
condition.
To illustrate the calculation of internal rate of return, consider
the cash flows of a project:

Year 0 1 2 3 4

Cash (100,000 30,000 30,000 40,000 45,000

)
Flow
The internal rate of return is the value of “ r ” which satisfies
the following equation:

100,000 = 30,000/ (1+r)1 + 30,000/ (1+r)2 + 40,000/ (1+r)3 + 45,000/ (1+r)

4

The calculation of “ r ” involves a process of trial and error. We try

different values of “ r ” till we find that right –hand side of the
above equation is equal to 100,000.

Let us, to begin with, r=15%. This makes the right-hand side equal
to:
30,000 / (1.15) + 30,000 / (1.15)1 + 30,000 / (1.15)2 + 30,000 / (1.15)3 + 30,000 /
(1.15)4
=100,802

30,000 / (1.16) + 30,000 / (1.16)1 + 30,000 / (1.16)2 + 30,000 / (1.16)3 + 30,000 /

(1.16)4
=98,641

Since 98,641 is now less than 100,000, we conclude that

the value of “ r ” lies between 15% and 16% and for
most of the purposes this approximation suffices.
Benefit – Cost Ratio (BCR):
There are two ways of defining the relationship between
benefits and costs:

Benefit - Cost Ratio : BCR = PVB / I

Net Benefit – Cost Ratio: NBCR = PVB – 1 / I

Where:
PVB = Present Value of Benefits
I = Initial Investment

Rule is:
When BCR Or NBCR Rule is
>1 >0 Accept
=1 =0 Indifferent
<1 <0 Reject
To illustrate the calculation of these measure, let us consider a
project which is being evaluated by a firm that has a cost of
capital of 12%.
Year 1 2 3 4

Initial (100,000) 0 0 0
investme
nt
Benefits 25,000 40,000 40,000 50,000

The benefit cost ratio measures for this project are:

25,000/ (1.12) + 40,000 / (1.12)1 + 40,000 / (1.12)2 + 40,000 / (1.12)3 + 40,000 /

(1.12)4

BCR =
100,000

BCR = 1.145 Accept

NBCR = BCR – 1 =1.145 – 1 = 0.45 Accept