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Practical Questions – Capital Budgeting & Investment Decision

Q1. Sanchit & Co. is considering the introduction of a new product. The firm estimates that it can sell annual 10,000
units of this product at Rs. 20 per unit. Variable expenses to produce and sell the product are estimated at Rs. 12
per unit. It will also involve cash fixed costs of Rs. 10,000 per annum. The plant to manufacture the product is
available for Rs. 2,00,000. Further, Rs. 40,000 will be needed to install the plant. The salvage value of the plant
after its life of 10 years is estimated to be Rs. 10,000. A working capital investment of Rs. 60,000 would be
required in the year of installing the plant. The firm uses the straight line method of depreciation on the
plant. Assuming 50% tax rate for this firm, you are required to calculate- (a) inital investment; (b) annual
net cash inflows; and (c) terminal cash inflows.
(Ans. (a) 3,00,000; (b) 46,500; (c) 70,000)

Q2. X Ltd. is considering the purchase of a new machine which will carry out some operations at present performed
by labour. Two alternative models— A and B are available for the purpose. Prepare a profitability statement
showing pay-back period from the following information
Machine A Machine B
Estimated Life (Years) 5 6
Cost of Machine (Rs.) 80,000 1,50,000
Estimated additional cost (Rs.)
Maintenance (p.m.) 500 750
Indirect Material (p.a.) 2,000 3,000
Supervision (per quarter) 3,000 4,500
Estimated savings in scrap (p.a.) Rs. 8,000 12,000
Estimated savings in direct wages (p.a.)
Employees not required 10 15
Wages per employee (Rs.) 7,200 7,200
Depreciation is calculated using Straight Line Method. Taxation may be taken at 50% of profit (net savings).
(Ans. Pay-back Period A – 2.11 years; B – 2.61 years)

Q3. A Limited Company is considering investing in a project requiring a capital outlay of Rs. 1,00,000. Forecasts of
annual income after depreciation but before tax is as follows:
Year 1 2 3 4 5
Amount (Rs.) 50,000 50,000 40,000 40,000 20,000
Depreciation may be taken at 20% on original cost and income tax at 50% of net income. Evaluate the project
using pay-back method.
𝟏
(Ans. Pay-back period – 2 𝟒 years)

Q4. ABC Ltd. is considering investing in a project that costs Rs. 5,00,000. The estimated salvage value is zero; tax rate
is 35 per cent. The company uses straight line depreciation for tax purposes and the proposed project has cash
flows before depreciation and tax (CFBDT) as follows :
Year 1 2 3 4 5
CFBDT (Rs.) 1,00,000 1,00,000 1,50,000 1,50,000 2,50,000
Determine the following: (i) Pay-back period, and (ii) Average rate of return.
(Ans. (i) 4.18 years; (ii) 13%)

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Q5. Find out the Net Present Value for which a project requires an initial investment of Rs. 25,000 and involves a net
cash inflow of Rs. 12,000 each for 3 years. The cost of funds is 8% There is no scrap value. The present value of an
annuity of Re 1 for 3 years at 8% per annum is Rs. 2.577%.
(Ans. NPV – Rs. 5,924)

Q6. No project is acceptable unless the yield is 10%. Cash inflows of a certain project along with cash outflows are
given below:
Year 0 1 2 3 4 5
Outflows (Rs.) 1,50,000 30,000 — — — —
Inflows (Rs.) — 20,000 30,000 60,000 80,000 30,000
The salvage value at the end of the 5th year is Rs. 40,000. Calculate net present value. The present value of Re. 1
for five years at 10% discount factor is .909, .826, .751, .683 and .621 respectively.
(Ans. NPV – Rs. 8,860)

Q7. From the following information, calculate the net present value of the two projects and suggest which of the
projects should be accepted assuming a discount rate of 10%.
Project X Project Y
Rs. Rs.
Initial Investment 20,000 30,000
Estimated Life 5 years 5 years
Scrap Value 1,000 2,000
The profits before depreciation and after taxes (cash-flows) are as follows:
Years 1 2 3 4 5
Project X Rs. 5,000 10,000 10,000 3,000 2,000
Project Y Rs. 20,000 10,000 5,000 3,000 2,000
(Ans. NPV Project X – Rs. 4,227; Project Y – Rs. 4,728)

Q8. A project costing Rs. 100 lakhs has a life of 10 years at the end of which its scrap value is likely to be Rs. 10 lakhs.
The firm‘s cut-off rate is 12%. The project is expected to yield an annual profit after tax and depreciation of Rs. 10
lakhs, depreciation being charged on straight line basis. At 12% p.a, the present value of one rupee received
annually for 10 years is Rs. 5.650 and the value of one rupee received at the end of 10th year is Rs. 0.322.
Ascertain the net present value of the project and state whether we should go in for the project.
(Ans. NPV – Rs. 10,57,000)

Q9. A project costs a initial investment of Rs 40,000 and is expected to annual cash inflows of Rs. 16,000 for 4 years.
Calculate internal rate of return (IRR). Present Value of Re. 1 at varying discount rates for a period of 4 years.
Years 19% 20% 22%
1 0.8403 0.8333 0.8196
2 0.7062 0.6944 0.6719
3 0.5934 0.5787 0.5507
4 0.4987 0.4823 0.4514
Total 2.6386 2.5887 2.4936
(Ans. IRR – 21.866%)

Q10. A project with an initial investment of Rs, 10,000 generates cash inflows of Rs. 5,000; Rs. 4,000 and Rs. 3,000 with
life of 3 years. What will be the internal rate of return?
(Ans. IRR – 10.65%)

Q11. Bright Metals Ltd. are considering two different investment proposals. The details are as under.

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Proposal — A Proposal — B
Rs. Rs.
Investment Cost 9,500 20,000
Estimated Cash inflows at the end of
Year I 4,000 8,000
Year ll 4,000 8,000
Year Ill 4,500 12,000
(a) Suggest the n1ost attractive proposal on the basis of Excess Present Value Method considering future cash
inflows are discounted at 12%.
(b) Also find out the Internal Rate of Return of the two proposals.
The present value of Re. 1 receivable at the end of each period on various rates of discount are:
Year 10% 12% 14% 15% 16% 17% 18%
1 .9091 .8929 .8772 .8696 .8621 .8547 .8475
2 .8265 .7972 .7695 .7561 .7432 .7305 .7182
3 .7513 .7118 .6750 .6575 .6407 .6244 .6086
(Ans. (a) NPV Proposal A – 464; Proposal B – 2,063; (b) IRR Proposal A – 14.76%; Proposal B – 17.5%)

Q12. Using the information given below, compute the Pay-back period under Discounted Pay-back Method.
Initial Outlay Rs. 80,000
Estimated Life 5 years
th
End of the year 1st 2nd 3rd 4 5th
Profit after tax (Rs.) 6,000 14,000 24,000 16,000 Nil
Depreciation has been calculated under straight line method. The cost of capital may be taken at 20% p.a. and
P.V. of Re. 1 at 20% is given below:
Year 1 2 3 4 5
P V. Factor .83 .69 .58 .48 .40
(Ans. Pay-back period - 4.4 years)

Q13. A firm buys an asset costing Rs. 1,00,000 and expects operating profits (before depreciation @ 20%. WDV and tax
@ 30%) of Rs. 30,000 p.a. for the next four years after which the asset would be disposed off for Rs. 40,000. Find
out the cash flows for different years.
(Ans. Cash inflows 1st year -27,000, 2nd year – 25,800, 3rd year – 24,840, 4th year – 64,072)

RTP
Q14. ASG Ltd. is considering a project “Z” with an initial outlay of ₹ 15,00,000 and life of 5 years. The estimates of
project are as follows:
Lower Estimates Base Upper Estimates
Sales (units) 9,000 10,000 11,000
(₹) (₹) (₹)
Selling Price p.u. 175 200 225
Variable cost p.u. 100 125 150
Fixed Cost 1,00,000 1,50,000 2,00,000
Depreciation included in Fixed cost is ₹ 70,000 and corporate tax is 25%.
Assuming the cost of capital as 15%, DETERMINE NPV in three scenarios i.e worst, base and best case
scenario.
PV factor for 5 years at 15% are as follows:
Years 1 2 3 4 5
P.V. 0.870 0.756 0.658 0.572 0.497
factor
(Ans: Cash Inflow: Worst Case: 88,750; Base: 5,20,000; Best Case: 10,26,250; NPV: Worst Case: (12,02,421.25);
Base: 2,43560.00; Best Case: 19,41,016.25)

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Q15. Remi limited is a manufacturer of mobile phones in India. Currently the company is dependent on the
foreign supplier for import of the battery. It is considering investment of ₹ 55,00,000 in a new machine for
manufacturing battery of mobile phones. The expected life of machine is 5 years and has no scrap
value. It is expected that 3 lakhs units will be produced and sold each year at a selling price of ₹ 20 per
unit. The estimated variable costs and annual fixed costs will be ₹12 per unit and ₹ 6,00,000
respectively. Consider 14% to be an appropriate cost of capital. Ignore the taxation and depreciation.
CALCULATE the expected net present value of the project.
You are also REQUIRED to measure the sensitivity of the projects NPV to a 10% decrease in the project
variables sale price per unit and sales volume and 10% increase in Fixed Cost.
Ans:

Original Scenario Sale Price Sales Volume Fixed Cost

reduced by 10% reduced by 10% increased by
10%
NPV ₹6,79,546 ₹ (13,80,303) ₹ (1,44,394) ₹ 4,73,561
Sensitivity NA 30.3121 times 12.1249 times 3.0312 times

Q16. TIP Ltd. is considering two mutually exclusive projects M and N. You have been given below the Net Cash flow
probability distribution of each project:

Project-M Project-N
Net Cash Flow (₹) Probability Net Cash Flow (₹) Probability
62,500 0.30 1,62,500 0.20
75,000 0.30 1,37,500 0.30
87,500 0.40 1,12,500 0.50
(i) REQUIRED:
(a) Expected Net Cash Flow of each project.
(b) Variance of each project.
(c) Standard Deviation of each project.
(d) Coefficient of Variation of each project.
(ii) IDENTIFY which project would you recommend? Give reasons.
(Ans. ENCF: M: 76,250; N: 1,30,000; Variance: M: 10,78,12,000; N: 38,12,50,000; SD: M:
10,383.2798; N: 19,525.6242; CV: M: 13.62%; N: 15.02%)

Q17. Consider the below mentioned table for the risk premium and the coefficient of variation:
Co-efficient of Variation Risk Premium
0 0
0 to 0.25 2%
0.25 to 0.50 3%
0.50 to 0.75 4%
0.75 to 1 6%
A company is evaluating two projects with an initial investment of ₹ 1,50,000 for each project with cash inflows
from them occurring at the end of 5th Year which depends on possible scenarios prevailing during the investment
period. The details of the same are as follows:

Scenario Project X Project Y

Cash Flow (₹) Probability Cash Flow (₹) Probability
Superb 5,00,000 0.20 4,00,000 0.30
Better 3,00,000 0.30 3,50,000 0.20
Moderate 1,50,000 0.15 2,50,000 0.20
Bad 50,000 0.20 75,000 0.20
Worse 10,000 0.15 5,000 0.10
If the ongoing government bond yield is 6%, identify WHICH project to be undertaken.
(Ans: X: SD = 1,75,254; COV: 0.7824; Y: SD = 1,44,386; COV: 0.5651; RADR: X= ; Y= ; NPV: X= (22,902); Y= 8,640)
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Q18. ABC & Co. is considering whether to replace an existing machine or to spend money on revamping it. ABC & Co.
currently pays no taxes. The replacement machine costs ₹ 18,00,000 now and requires maintenance of ₹ 2,00,000
at the end of every year for eight years. At the end of eight years, it would have a salvage value of ₹ 4,00,000 and
would be sold. The existing machine requires increasing amounts of maintenance each year and its salvage value
fall each year as follows:
Year Maintenance (₹) Salvage (`)
Present 0 8,00,000
1 2,00,000 5,00,000
2 4,00,000 3,00,000
3 6,00,000 2,00,000
4 8,00,000 0
The opportunity cost of capital for ABC & Co. is 15%.
REQUIRED:
When should the company replace the machine?
The following present value table is given for you:
Year Present value of ₹ 1 at
15% discount rate
1 0.8696
2 0.7561
3 0.6575
4 0.5718
5 0.4972
6 0.4323
7 0.3759
8 0.3269
(Ans: EAC: 5,71,992; PV: 2,28,008; (2,36,524); (6,82,013); (11,15,445); (16,55,365))

Q19. Dharma Ltd, an existing profit-making company, is planning to introduce a new product with a projected life of 8
years. Initial equipment cost will be ₹ 240 lakhs and additional equipment costing ₹ 26 lakhs will be needed at the
beginning of third year. At the end of 8 years, the original equipment will have resale value equivalent to the cost
of removal, but the additional equipment would be sold for ₹ 2 lakhs. Working Capital of ₹ 25 lakhs will be needed
at the beginning of the operations. The 100% capacity of the plant is of 4,00,000 units per annum, but the
production and sales volume expected are as under:
Year Capacity
(%)
1 20
2 30
3-5 75
6-8 50
A sale price of ₹ 100 per unit with a profit volume ratio (contribution/sales) of 60% is likely to be obtained. Fixed
operating cash cost are likely to be ₹ 16 lakhs per annum. In addition to this the advertisement expenditure will
have to be incurred as under:
Year 1 2 3-5 6-8
Expenditure (₹ Lakhs each year) 30 15 10 4
The company is subjected to 50% tax rate and consider 12% to be an appropriate cost of capital. Straight line
method of depreciation is followed by the company. ADVISE the management on the desirability of the project.
Ans:

Cash Flows after tax 1 2 3-5 6-8

16,00,000 35,50,000 94,00,000 67,00,000
(NPV: 39,09,850)

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Q20. HMR Ltd. is considering replacing a manually operated old machine with a fully automatic new machine.
The old machine had been fully depreciated for tax purpose but has a book value of ₹ 2,40,000 on 31st
March 2021. The machine has begun causing problems with breakdowns and it cannot fetch more than ₹
30,000 if sold in the market at present. It will have no realizable value after 10 years. The company has
been offered ₹ 1,00,000 for the old machine as a trade in on the new machine which has a price (before
allowance for trade in) of ₹ 4,50,000. The expected life of new machine is 10 years with salvage value of
₹ 35,000.
Further, the company follows straight line depreciation method but for tax purpose, written down value
method depreciation @ 7.5% is allowed taking that this is the only machine in the block of assets.
Given below are the expected sales and costs from both old and new machine:
Old machine (₹) New machine (₹)
Sales 8,10,000 8,10,000
Material cost 1,80,000 1,26,250
Labour cost 1,35,000 1,10,000
Variable overhead 56,250 47,500
Fixed overhead 90,000 97,500
Depreciation 24,000 41,500
PBT 3,24,750 3,87,250
Tax @ 30% 97,425 1,16,175
PAT 2,27,325 2,71,075
From the above information, ANALYSE whether the old machine should be replaced or not if required
rate of return is 10%? Ignore capital gain tax.
PV factors @ 10%:
Year 1 2 3 4 5 6 7 8 9 10
PVF 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386
Ans: (PFTD: Old: 3,48,750; New: 4,28,750; Differece: 80,000; Incremental NPV: 44,512.44)

Q21. K. K. M. M Hospital is considering purchasing an MRI machine. Presently, the hospital is outsourcing the work
received relating to MRI machine and is earning commission of ₹ 6,60,000 per annum (net of tax). The following
details are given regarding the machine:
₹
Cost of MRI machine 90,00,000
Operating cost per annum (excluding Depreciation) 14,00,000
Expected revenue per annum 45,00,000
Salvage value of the machine (after 5 years) 10,00,000
Expected life of the machine 5 years
Assuming tax rate @ 40%, whether it would be profitable for the hospital to purchase the machine?
Give your RECOMMENDATION under:
(i) Net Present Value Method, and
(ii) Profitability Index Method.
PV factors at 10% are given below:

Year 1 2 3 4 5
PV factor 0.909 0.826 0.751 0.683 0.620
[Net cash inflow: 28,40,000; NPV: (14,08,240), Profitablity Index: 0.844]

Suggested Answers
Q22. Stand Ltd. is contemplating replacement of one of its machines which has become outdated and inefficient. Its
financial manager has prepared a report outlining two possible replacement machines. The details of each
machine are as follows:
Machine 1 Machine 2
Initial investment ₹12,00,000 ₹16,00,000
Estimated useful life 3 years 5 years

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Residual value ₹1,20,000 ₹1,00,000
Contribution per annum ₹11,60,000 ₹12,00,000
Fixed maintenance costs per annum ₹40,000 ₹80,000
Other fixed operating costs per annum ₹7,20,000 ₹6,10,000
The maintenance costs are payable annually in advance. All other cash flows apart from the initial investment
assumed to occur at the end of each year. Depreciation has been calculated by straight line method and has been
included in other fixed operating costs. The expected cost of capital for this project is assumed as 12% p.a.
Required:
(i) Which machine is more beneficial, using Annualized Equivalent Approach? Ignore tax.
(ii) Calculate the sensitivity of your recommendation in part (i) to changes in the contribution generated by
machine 1.
Year 1 2 3 4 5 6
PVIF0.12,t 0.893 0.797 0.712 0.636 0.567 0.507
PVIFA0.12,t 0.893 1.690 2.402 3.038 3.605 4.112
(Ans: Machine 1: NCF= ₹9,20,000; Machine 1: NCF= ₹9,90,000;

Q23. K.P. Ltd. is investing ₹ 50 lakhs in a project. The life of the project is 4 years. Risk free rate of return is 6% and risk
premium is 6%, other information is as under:
Sales of 1st year ₹ 50 lakhs
Sales of 2nd year ₹ 60 lakhs
Sales of 3rd year ₹ 70 lakhs
Sales of 4th year ₹ 80 lakhs
P/V Ratio (same in all the years) 50%
Fixed Cost (Excluding Depreciation) of 1st year ₹ 10 lakhs
Fixed Cost (Excluding Depreciation) of 2nd year ₹ 12 lakhs
Fixed Cost (Excluding Depreciation) of 3rd year ₹ 14 lakhs
Fixed Cost (Excluding Depreciation) of 4th year ₹ 16 lakhs
Ignoring interest and taxes,
You are required to calculate NPV of given project on the basis of Risk Adjusted Discount Rate.
Discount factor @ 6% and 12% are as under:
Year 1 2 3 4
Discount Factor @ 6% 0.943 0.890 0.840 0.792
Discount Factor@ 12% 0.893 0.797 0.712 0.636
(Ans: NPV= 7.957)

Q24. An existing company has a machine which has been in operation for two years, its estimated remaining useful life
is 4 years with no residual value in the end. Its current market value is ₹ 3 lakhs. The management is considering a
proposal to purchase an improved model of a machine gives increase output. The details are as under:
Particulars Existing Machine New Machine
Purchase Price ₹6,00,000 ₹ 10,00,000
Estimated Life 6 years 4 years
Residual Value 0 0
Annual Operating days 300 300
Operating hours per day 6 6
Selling price per unit ₹10 ₹ 10
Material cost per unit ₹2 ₹2
Output per hour in units 20 40
Labour cost per hour ₹ 20 ₹ 30
Fixed overhead per annum excluding depreciation ₹ 1,00,000 ₹ 60,000
Working Capital ₹ 1,00,000 ₹ 2,00,000
Income-tax rate 30% 30%
Assuming that - cost of capital is 10% and the company uses written down value of depreciation @ 20%
and it has several machines in 20% block.
Advice the management on the Replacement of Machine as per the NPV method.

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The discounting factors table given below:
Discounting Year 1 Year 2 Year 3 Year 4
Factors
10% 0.909 0.826 0.751 0.683
(Ans: Net initial cash outflow: 8,00,000; PBTD: Existing: 1,52,000; New: 4,62,000; Differencial: 3,10,000; NPV:
56,778.712)

Q25. P Ltd. is considering a project with the following details:

(i) MEASURE the sensitivity of the project to change in initial project cost and Annual cash inflows
(considering each factor at a time) such that NPV become zero.
(ii) IDENTIFY which of the two factors; the project is most sensitive to affect the acceptability of the project?

Year 1 2 3 4 5
PVIF0.10, t 0.909 0.826 0.751 0.683 0.621
(Ans: NPV: 38,840; Sensitivity analysis: 34.84%; 27.97%)

Q26. Alpha Limited is a manufacturer of computers. It wants to introduce artificial intelligence while making
computers. The estimated annual saving from introduction of the artificial intelligence (AI) is as follows:
• reduction of five employees with annual salaries of ₹ 3,00,000 each
• reduction of ₹ 3,00,000 in production delays caused by inventory problem
• reduction in lost sales ₹ 2,50,000 and
• Gain due to timely billing ₹ 2,00,000
The purchase price of the system for installation of artificial intelligence is ₹ 20,00,000 and installation
cost is ₹ 1,00,000. 80% of the purchase price will be paid in the year of purchase and remaining will be
paid in next year.
The estimated life of the system is 5 years and it will be depreciated on a straight-line basis.
However, the operation of the new system requires two computer specialists with annual salaries of ₹
5,00,000 per person.
In addition to above, annual maintenance and operating cost for five years are as below:
(Amount in ₹)
Year 1 2 3 4 5
Maintenance & Operating 2,00,000 1,80,000 1,60,000 1,40,000 1,20,000
Cost
Maintenance and operating cost are payable in advance.
The company's tax rate is 30% and its required rate of return is 15%.
Year 1 2 3 4 5
PVIF 0.10, t 0.909 0.826 0.751 0.683 0.621
PVIF 0.12, t 0.893 0.797 0.712 0.636 0.567
PVIF 0.15, t 0.870 0.756 0.658 0.572 0.497
Evaluate the project by using Net Present Value and Profitability Index.
(Net CFAT: Year 0: (2,00,000); Year 1: 8,81,000 ; Year 2: 8,95,000 ; Year 3: 9,09,000 ; Year 4: 9,23,000 ; Year 5:
10,37,000; PI: 1.408)

Q27. Determine the Risk Adjusted Net Present Value of the following projects:
A B C

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Net cash outlays (₹) 70,000 1,20,000 2,20,000
Project life 5 years 5 years 5 years
Annual cash inflow (₹) 30,000 42,000 70,000
Coefficient of Variation 2.2 1.6 1.2
The company selects the risk-adjusted discount rate on the basis of the Coefficient of variation.
Coefficient of Variation Applicable Risk adjusted PVIFA (i,5)
discount rate (i)
0 10% 3.791
0.4. 12% 3.605
0.8 14% 3.433
1.2 16% 3.274
1.6 18% 3.127
2 22% 2.864
>2.0 25% 2.689
Which project should be selected by the company based on Risk Adjusted NPV?
(Ans: NPV: A: 10,670; B: 11,334; C: 9,180)

Q28. A firm is in need of a small vehicle to make deliveries. It is intending to choose between two options.
One option is to buy a new three wheeler that would cost ` 1,50,000 and will remain in service for 10
years.
The other alternative is to buy a second hand vehicle for ` 80,000 that could remain in service for 5 years.
Thereafter the firm, can buy another second hand vehicle for ` 60,000 that will last for another 5 years.
The scrap value of the discarded vehicle will be equal to it written down value (WDV). The firm pays 30%
tax and is allowed to claim depreciation on vehicles @ 25% on WDV basis.
The cost of capital of the firm is 12%.
You are required to advise the best option.
Given:
t 1 2 3 4 5 6 7 8 9 10
PVIF 0.892 0.797 0.711 0.635 0.567 0.506 0.452 0.403 0.360 0.322
(t,12%)
(Ans: PVNOF: 78,686)

Q29. Beta Company Limited is considering replacement of its existing machine by a new machine, which is expected to
cost ₹ 2,64,000. The new machine will have a life of five years and will yield annual cash revenues of ₹ 5,68,750
and incur annual cash expenses of ₹ 2,95,750. The estimated salvage value of the new machine is ₹ 18,200. The
existing machine has a book value of ₹ 91,000 and can be sold for ₹ 45,500 today.
The existing machine has a remaining useful life of five years. The cash revenues will be 4,55,000 and associated
cash expenses will be ₹ 3,18,500. The existing machine will have a salvage value of ₹4,550, at the end of five
years.
The Beta Company is in 35% tax-bracket, and write off depreciation at 25% on written-down value method.
The Beta Company has a target debt to value ratio of 15%. The Company in the past has raised debt at 11% and it
can raise fresh debt at 10.5%.
Beta Company plans to follow dividend discount model to estimate the cost of equity capital. The Company plans
to pay a dividend of 2 per share in the next year. The current market price of Company's equity share is ₹ 20 per
equity share. The dividend per equity share of the Company is expected to grow at 8% p.a.
Required:
1. Compute the incremental cash flows of the replacement decision.
2. Compute the weighted average cost of Capital of the Company.
3. Find out the net present value of the replacement decision.
4. Estimate the discounted payback period of the replacement decision.
5. Should the Company replace the existing machine? Advise.
(Incremental cash: (2,18,500); 1,03,862; 1,00,078; 97,240; 95,111; 1,16,756; WACC: 16.32%; NPV: 1,13,295;
Discount payback period: 2 years, 10 months & 22 days)

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Q30. PD Ltd. an existing company, is planning to introduce a new product with projected life of 8 years. Project cost will
be ₹ 2,40,00,000. At the end of 8 years no residual value will be realized. Working capital of ₹ 30,00,000 will be
needed. The 100% capacity of the project is 2,00,000 units p.a. but the Production and Sales Volume is expected
are as under:
Year Number of Units
1 60,000 units
2 80,000 units
3-5 1,40,000 units
6-8 1,20,000 units.
Other Information:
1. Selling price per unit 200.
2. Variable cost is 40% of sales.
3. Fixed cost p.a. ₹ 30,00,000.
4. In addition to these advertisement expenditure will have to be incurred as under:
Year 1 2 3-5 6-8
Expenditure (₹) 50,00,000 25,00,000 10,00,000 5,00,000
5. Income Tax is 25%.
6. Straight line method of depreciation is permissible for tax purpose.
7. Cost of capital is 10%.
8. Assume that loss cannot be carried forward.
Present value table
Year 1 2 3 4 5 6 7 8
PVF @ 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467
Advice about the project acceptability.
(PV: 3,89,36,100; NPV: 1,19,36,100, accept)

Q31. Four years ago, Z Ltd. had purchased a machine of ₹ 4,80,000 having estimated useful life 7of 8 years with zero
salvage value. Depreciation is charged using SLM method over the useful life. The company want to replace this
machine with a new machine. Details of new machine are as below:
 Cost of new machine is ₹ 12,00,000. Vendor of this machine is agreed to take old machine at a value of ₹
2,40,000. Cost of dismantling and removal of old machine will be ₹ 40,000. 80% of net purchase price will be
paid on spot and remaining will be paid at the end of one year.
 Depreciation will be charged @ 20% p.a. under WDV method.
 Estimated useful life of new machine is four years and it has salvage value of ₹ 1,00,000 at the end of year
four.
 Incremental annual sales revenue is ₹ 12,25,000.
 Contribution margin is 50%.
 Incremental indirect cost (excluding depreciation) is ₹ 1,18,750 per year.
 Additional working capital of ₹ 2,50,000 is required at the beginning of year one and ₹ 3,00,000 at the
beginning of year three. Working capital at the end of year four will be nil.
 Tax rate is 30%.
 Ignore tax on capital gain.
Z Ltd. will not make any additional investment, if it yields less than 12%.
Advice, whether existing machine should be replaced or not.
Year 1 2 3 4 5
PVIF 0.12,t 0.893 0.797 0.712 0.636 0.567

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