Capital Budgeting Calculator
Evaluate investment projects with multiple metrics
Capital Budgeting Formulas
Understanding Capital Budgeting
Capital budgeting is the process of evaluating long-term investment projects. It answers: should we spend money today for expected future benefits? Good capital budgeting maximizes firm value.
Multiple metrics are used because each captures different aspects. NPV measures absolute value creation. IRR measures return rate. Payback measures liquidity risk. Together they provide a complete picture.
The discount rate represents the cost of capital—the minimum return required to justify the investment. Projects with NPV > 0 create value; those with NPV < 0 destroy value.
Key Capital Budgeting Metrics
NPV
Present value of all cash flows. Positive = creates value. The gold standard.
IRR
Rate of return that makes NPV = 0. Compare to cost of capital.
Payback Period
Years to recover initial investment. Simple liquidity measure.
Profitability Index
NPV per dollar invested. Useful for capital rationing.
Decision Rules
| Metric | Accept If | Reject If | Notes |
|---|---|---|---|
| NPV | NPV > 0 | NPV < 0 | Best single metric |
| IRR | IRR > Cost of Capital | IRR < CoC | Use with caution |
| Payback | < Target Payback | > Target | Ignores TVM |
| PI | PI > 1.0 | PI < 1.0 | Same as NPV > 0 |
| Disc. Payback | < Project Life | > Life | Includes TVM |
Capital Budgeting Best Practices
Use Multiple Metrics
No single metric tells the whole story. NPV + payback + sensitivity analysis together.
Estimate Cash Flows Carefully
Garbage in, garbage out. Be realistic about revenues, costs, and timing.
Run Sensitivity Analysis
What if sales are 20% lower? What if costs rise? Test key assumptions.
Consider Strategic Value
Some projects enable future options (R&D, market entry). Quantify if possible.
Frequently Asked Questions
NPV vs IRR: which is better?
NPV is theoretically superior—it measures absolute value creation and handles reinvestment correctly. IRR can give misleading results with non-normal cash flows. Use NPV as primary, IRR as supplement.
What discount rate should I use?
Use the Weighted Average Cost of Capital (WACC) for projects with average risk. Adjust up for riskier projects, down for safer ones. Many companies add risk premiums to WACC.
How do I handle uncertain cash flows?
Use expected values (probability-weighted averages), run scenario analysis (best/base/worst), or use Monte Carlo simulation for complex projects. Always test sensitivity.
Should I include sunk costs?
No. Sunk costs are already spent regardless of decision. Only include incremental cash flows—those that change if you accept the project.
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