FINANCIAL MANAGEMENT

Problems on Capital Budgeting

1. Calculate the payback period of the following projects each requiring a cash outlay of Rs.
1,00,000. Suggest which project is acceptable if the standard pay back period is 5 years.
Year Cash Inflows
Project A Project B
1 30,000 30,000
2 30,000 40,000
3 30,000 20,000
4 30,000 10,000
5 30,000 5,000

2. A project cost Rs. 25,000 and has a scrap value of Rs. 5,000 after 5 years. The net
profits before depreciation and taxes for five years period are expected to be Rs. 5,000,
Rs. 6,000, Rs. 7,000, Rs. 8,000 and Rs. 10,000. You are required to calculate the
ARR assuming 50 % rate of tax and depreciation on SLM.
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3. The Finance Manager of a company has the following data : Operational life of the project
is 4 years, the earnings before depreciation, interest and taxes are expected to be Rs.
44,000, Rs. 62,000, Rs. 78,000 and Rs. 86,000. Depreciation is on Straight Line Basis
and tax rate for the company is 25 %. The investment required in the project is Rs.
1,92,000. Find the ARR of the project.
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4. A Limited Company is considering investment in a project requiring a capital outlay of Rs.

2,00,000. Forecast of annual net cash flows (CFAT) are as follows :
Year : 1 2 3 4 5
CFAT : 50,000 50,000 50,000 50,000 50,000
Calculate Net Present Value taking cost of capital as 10 %.
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5. Calculate Profitability Index from the following data :

Project Cost = Rs. 10,00,000
Cash Inflows
I Year = Rs. 2,80,000
II Year = Rs. 3,60,000
III Year = Rs. 4,00,000
IV Year = Rs. 5,00,000
Cost of capital = 10 %.
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6. Calculate NPV from the following data :
(a) Investment in fixed assets = Rs. 4,00,000
(b) Investment in permanent working capital = Rs. 1,00,000
Project Inflows :
Year I = Rs. 1,80,000
Year II = Rs. 2,00,000
Year III = Rs. 3,00,000
Year IV = Rs. 3,20,000
Rate of discounting = 12 %.
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7. A firm is contemplating the following projects, which one is better according to you :
Year Project A Project B
0 -1,00,000 -1,00,000
1 25,000 35,000
2 24,000 20,000
3 23,000 24,000
4 20,000 23,000
5 15,000 18,000
On the basis of NPV , Profitability Index and Pay-back period, evaluate the projects
assuming a 10 % discount rate.
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8. An investment project requires an initial investment of Rs. 54,000 and is expected to

generate cash inflows of Rs. 15,000, Rs. 22,000, Rs. 30,000, Rs. 24,000, Rs. 18,000
and Rs. 12,000 from 1 to 6 years. The required cost of capital for the firm is 12 %.
Find the NPV and PI of the project.
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9. An investment project requires an initial investment of Rs. 65,000 and is expected to

generate Rs. 15,000 per annum for 8 years. The cost of capital for the firm is 8 %.
Find the NPV and PI of the projects.
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10. A company is considering an investment proposal, involving an initial cash outlay of Rs.
45 lakhs. The proposal has an expected life of 7 years and zero salvage value. At
required rate of return of 12 per cent, the proposal has profitability index of 1.82.
Calculate the annual cash inflows.
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11. A company is contemplating purchasing a new mass storage unit for its computer facility. It
is expected to cost Rs. 2,00,000. Further, the company estimates Rs. 20,000 as
permanent working capital. The projected net cash inflows from the proposed investment
project are as follows for each year of operations.
Year : 1 2 3 4 5
Gross Cash Inflows : 50,000 80,000 1,00,000 80,000 60,000
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 The company’s cost of capital is 12 %, advise the company whether the project should be
accepted or rejected, use the NPV method.
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12. Mr. Rao is considering the two mutually exclusive projects P and Q from the following
information, you are required to calculate NPV for each possible outcome assuming 16
% cost of capital and suggest which project is risky.
Project P Project Q
Initial Outlay 65,000 65,000
Cash Inflows estimation for 5 years
Years 1 and 2 20,000 10,000
Years 3 and 4 25,000 25,000
Year 5 35,000 45,000
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13. A company is considering a proposal to buy one of the two machines to manufacture a new
commodity. Each of the machine requires investment of Rs. 50,000 and is expected to
provide benefits over a period of 10 years. The firm has made estimates of cash flows.
The estimates are as follows :
Machine A Machine B
Investment 50,000 50,000
Cash Flow Estimates
Year 1 --- 5 10,000 8,000
Year 6 --- 8 12,000 10,000
Year 9 and 10 14,000 18,000
Assuming 12 % cost of capital, calculate NPV. Which machine should be selected.
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14. A limited company is considering investing in a project requiring a capital outlay of Rs.
1,00,000. The annual cash flows are given below :
Year Amount (Rs)
1 30,000
2 20,000
3 25,000
4 25,000
5 30,000
You are required to calculate the project according to NPV and Profitability Index at cost
of capital of 10 % and suggest whether the project is accepted or not.
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15. A company is considering two mutually exclusive projects. Both require an initial cash
outlay of Rs. 2,00,000 each and have a life of 5 years. The company’s required rate of
return is 10 percent and pays tax at 30 per cent. The projects will be depreciated on
straight line basis. The profit before depreciation and tax expected to be generated by the
projects are as follows :

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Year : 1 2 3 4 5
Project 1: 80,000 80,000 80,000 80,000 80,000
 Project 2: 1,20,000 60,000 40,000 1,00,000 98,000

Determine the NPV and benefit cost ratio for each project and indicate which project
should be accepted and why.
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16. A company is considering an investment proposal to install a new milling controls. The
project will cost Rs. 50,000. The facility has a life expectancy of 5 years and no salvage
value. The estimated cash flows after tax (CFAT) from the proposed investment proposal
are as follows :
Ke = 10 % per annum.
Year CFAT
1 20,000
2 21,000
3 14,000
4 15,000
5 25,000
Compute (i) Net Present Value (ii) Profitability Index at 10 % discount rate.
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17. A firm is considering a proposal to buy a machine for Rs. 30,000. The expected cash
flows after taxes from the machine for a period of 3 years are Rs. 20,000. After the
expiry of the useful life of the machine, the seller has guaranteed its re-purchase at Rs.
2,000. The firms cost of capital is 10 % and risk adjusted discount rate is 18 %. Should
the company accept the proposal.
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18. A company is considering the purchase of a machine to produce a new product. The new
product will generate revenue of Rs. 60,000 per year for 5 years. The cost of material
and labour needed to generate these revenues will total Rs. 35,000 per year and other
expenses will be Rs. 3,000 per year. Net working capital of Rs. 4,500 will be required
immediately and this amount will be freed up at the end of the fifth year.
The machine will cost Rs. 30,000. It will be depreciated on straight line basis over
its five year life. The tax rate is 40 % and the cost of capital is 12 %. Using the Net
Present Value, determine whether the machine has to be purchased or not.
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19. Projects A and B require an initial investment of Rs. 20,00,000 each, the life of both
the projects is five years. The information about projected cash flows and probabilities is
given below :
Type Project A Prob. Project B Prob.
Optimistic 8,00,000 0.4 10,00,000 0.2
Moderate 7,00,000 0.2 9,00,000 0.1
Poor 6,00,000 0.3 7,00,000 0.4
Pessimistic 5,00,000 0.1 6,00,000 0.3
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You are required to calculate NPV and rank the projects. The cost of capital of the
company is 10 %.
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20. A company is examining two mutually exclusive investment proposals. The management of
the company uses Certainty Equivalent (CE) to evaluate new investment proposals.
From the following information pertaining to these projects, advise the company which
project should be taken up by the company.
Year Proposal A Proposal B
CFAT CE CFAT CE
0 -25,000 1.0 -25,000 1.0
1 15,000 0.8 9,000 0.9
2 15,000 0.7 18,000 0.8
3 15,000 0.6 12,000 0.7
4 15,000 0.5 16,000 0.4
The firms cost of capital is 12 %.
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21. Find the NPV of a project when cost of capital is 10 %. Initial investment is Rs.
12,00,000. The project has a 6 years life, with zero salvage value. Depreciation is on
Straight Line Basis. Earnings before depreciation and taxes over the six years period are :
Year Amount (Rs)
1 4,00,000
2 5,00,000
3 3,00,000
4 2,00,000
5 3,00,000
6 2,00,000
Tax rate is 50 % , permanent increase in working capital is Rs. 75,000.
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22. From the following data, state which project is better.
Project A B
Cash Flow
Year 0 -10,000 -10,000
1 4,000 5,000
2 4,000 6,000
3 2,000 3,000
Risk less discount rate is 5 % , Project A is less risky as compared to Project B. The
Management considers risk premium rates at 5 % and 10 % respectively, appropriate for
discounting the cash flows of the projects.
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23. Two projects X and Y need initial investment of Rs. 25,000 and Rs. 40,000
respectively and the cost of capital is 8 %. The cash inflows of Projects X are Rs.
6,000, Rs. 9,000, Rs. 13,000 and Rs. 9,000. The cash inflows of Project Y are Rs.
18,000, Rs. 24,000, Rs. 20,000 and Rs. 16,000. The risk premium for the two projects
are 3 % and 4 % respectively. Using RADR, find the NPV of the two projects.
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24. Equipment A has a cost of Rs. 75,000 and net cash flow of Rs. 20,000 per year for 6
years. A substitute equipment B would cost Rs. 50,000 and generate net cash flow of
Rs. 14,000 per year for 6 years. The required rate of return of both equipment is 10 %.
 Calculate the Profitability Index and NPV of both equipment, which equipment should be
accepted and why.
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25. Which of the following two proposals is more risky ? Calculate and give your opinion using
sensitivity analysis for selecting one of the proposals.
Particulars Machine X Machine Y
Cost 50,00,000 50,00,000
Pessimistic 8,00,000 1,00,000
Most Likely 10,00,000 5,00,000
Optimistic 12,00,000 25,00,000
Cash flow annuity is to be estimated for 10 years and the cost of capital is 14 %.
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26. Following are the details of a project.

Initial Outlay = Rs. 80,000
Initial Working Capital = Rs. 20,000
Cash flow before depreciation and taxes.
1st Year = Rs. 35,000
nd
2 Year = Rs. 35,000
rd
3 Year = Rs. 30,000
th
4 Year = Rs. 30,000
Salvage Value = Rs. 20,000
The project is depreciable on SLM. If the required rate of return is 10 % , is the project
acceptable under the NPV and IRR criteria. Tax rate is 50 %.
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27. A company is considering two mutually exclusive projects. Both require an initial outlay of
Rs. 2,00,000 each and have a life of 5 years. The company’s required rate of return is
10 %. The expected cash flows are as follows :
Year Project X Project Y
1 80,000 1,20,000
2 80,000 60,000
3 80,000 40,000
4 80,000 1,00,000
5 80,000 1,00,000
Determine the NPV and IRR of each project and indicate which project should be
selected and why.
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28. An industry is contemplating to purchase a machine. Two machines A and B are
available, each costing Rs. 5,00,000. In comparing the profitability of machines a
discount rate of 10 % is used. Earnings after taxation are expected as follows :
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(Rs. 000)
Year Machine A Machine B
1 150 50
 2 200 150
3 250 200
4 150 300
5 100 200

Rank the investment proposals using :

(a) Pay-back Period.
(b) NPV @ 10 %.
(c) IRR Method.
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29. The expected cash flows of a project are as follows :

Year : 0 1 2 3 4 5
Cash flows : -1,00,000 20,000 30,000 40,000 50,000 30,000
The cost of capital is 12 %. Calculate the following :
(a) Internal Rate of Return.
(b) Discounted Pay-back Period.
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30. A project requires an investment of Rs. 1,44,000 and is expected to generate cash inflows
of Rs. 54,000, Rs. 63,000, Rs. 72,000, Rs. 63,000 and Rs. 54,000 per annum for
the next 5 years. The risk free rate is 10 %. Evaluate the project using IRR method.

If the following Certainty Equivalents are to be considered, how would you evaluate and
interpret the project.
Year : 1 2 3 4 5
CE : 0.96 0.92 0.88 0.82 0.79
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31. A company is considering a capital investment proposal where 2 alternatives are being
considered. Both investment have a 5 year life. In Option I, new machine would cost Rs.
2,78,000 and Option II, Rs. 8,50,000. Anticipated scrap values after 5 years are Rs.
28,000 and Rs. 1,50,000 respectively. Depreciation is provided on SLM. Option I
would generate annual Cash Inflows of Rs. 1,00,000 and Option II Rs. 2,50,000. The
cost of capital is 15 %. Calculate for each option :
(a) Pay-back Period.
(b) The ARR.
(c) The NPV.
(d) IRR.
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32. A choice is to be made between two competing projects which require an equal investment
of Rs. 50,000 and are expected to generate net cash flows as under :
 Year Project 1 Project 2
1 25,000 10,000
2 15,000 12,000
3 10,000 18,000
4 NIL 25,000
5 12,000 8,000
6 6,000 4,000
The cost of capital of the company is 10 %. Compute NPV and IRR and suggest which
project is acceptable.
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33. A firm whose cost of capital is 10 % is considering two mutually exclusive projects X and
Y, the details of which are :
Particulars Project X Project Y
Investment 70,000 70,000
Cash Inflows :
Year 1 10,000 50,000
Year 2 20,000 40,000
Year 3 30,000 20,000
Year 4 45,000 10,000
Year 5 60,000 10,000
Compute the NPV and IRR and suggest which project is acceptable.
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34. A project requires an investment of Rs. 10,00,000 and is expected to generate cash
inflows of Rs. 3,00,000, Rs. 3,50,000, Rs. 4,60,000, Rs. 3,80,000 and Rs. 3,25,000
for the next five years. The risk free cost of capital is 10 %. Evaluate the project using
IRR method.
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35. Rao & Co., provides the following estimates to the present values of the future expected
cash flows after taxes associated with investment proposal relating to the plant expansion.
PVCFAT Probabilities
Without Expansion With Expansion
2,00,000 4,50,000 0.2
3,50,000 7,00,000 0.3
5,00,000 5,00,000 0.5
The plant expansion costs Rs. 4,00,000. You are required to advice Rao & Co.,
regarding the financial feasibility on the investment with the use of decision tree approach.
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36. A project involves initial investment of Rs. 25,000 , life of the project is 4 years and
Cash Inflows are Rs. 12,000 per annum for 4 years. Cost of capital is 12 %. The
expected rate at which Cash Inflows will be re-invested at the end of the year are :
 Year : 1 2 3 4
Percentage : 5% 5% 10 % 10 %
You are required to analyse the feasibility of the project using Terminal Value method.
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