Financial Management

Capital Budgeting
100 Financial Management

(B) Choose the correct option from the followings :

1. Capital Budgeting is a part of :
(a) Investment Decision (b) Working Capital Management
(c) Marketing Management (d) Capital Structure
2. Capital budgeting deals with :
(a) Long Term Decision (b) Short Term Decisions
(c) both (a) and (b) (d) Neither (a) nor (b)
3. Which of the following is not used in capital budgeting :
(a) Time Value of Money (b) Sensitivity Analysis
(c) Net Assets Method (d) Cash Flow
4. Capital budgeting decisions are :
(a) Reversible (b) Irreversible
(c) Unimportant (d) All of these
5. Which of the following is not incorporated in capital budgeting ?
(a) Tax-effect (b) Time Value of Money
(c) Required Rate of Return (d) Rate of Cash Discount
6. Which of the following is not a capital budgeting decision ?
(a) Expansion Programme (b) Merger
(c) Replacement of an Asset (d) Inventory Level
7. A sound capital budgeting technique is based on :
(a) Cash Flows (b) Accounting Profit
(c) Interest Rate on Borrowings (d) Last Dividend Paid
8. Which of the following is not a relevant cost in capital budgeting ?
(a) Sunk Cost (b) Opportunity Cost
(c) Allocated Overheads (d) Both (a) and (c)
9. Capital budgeting decisions are based on :
(a) Incremental Profit (b) Incremental Cash Flows
(c) Incremental Assets (d) Incremental Capital
10. Which of the following does not effect cash flows from a proposal :
(a) Salvage Value (b) Depreciation Amount
(c) Tax Rate Change (d) Method of Project Financing
11. Cash flows from a project include :
(a) Tax Shield of Depreciation (b) After Tax Operating Profits
(c) Raising of Funds (d) both (a) and (b)
12. Which of the following is not true with reference to capital budgeting :
(a) Capital budgeting is related to assets replacement decisions
(b) Cost of capital is equal to minimum required rate of return
(c) Existing investment in a project is not treated as sunk cost
(d) Timing of cash flow is relevant
13. Which of the following is not followed in capital budgeting ?
(a) Cash Flow Principle (b) Interest Exclusion Principle
(c) Accrual Principle (d) Post Tax Principle
14. Depreciation is incorporated in cash flows because it :
(a) Is unavoidable cost (b) Is a cash flow
(c) Reduces tax liability (d) Involves an outflow
15. Which of the following is not true for capital budgeting ?
(a) Sunk costs are ignored (b) Opportunity costs are excluded
(c) Incremental cash flows are considered (d) Relevant cash flows are considered
16. Which of the following is not applied in capital budgeting ?
(a) Cash flows be calculated in incremental terms
(b) All costs and benefits are measured on cost basis
(c) All accrued cost and revenues be incorporated
(d) All benefits are measured on after tax basis
Capital Budgeting 101

17. Evaluation of capital budgeting proposals is based on cash flows because :

(a) Cash flows are easy to calculate (b) Cash flows are suggested by SEBI
(c) Cash is more important than profit (d) None of these
18. Which of the following is not included in incremental cash flows :
(a) Opportunity Costs (b) Sunk Costs
(c) Change in Working Capital (d) Inflation Effect
19. A proposal is not a capital budgeting proposal if it :
(a) Is related to fixed assets (b) Brings long term benefits
(c) Brings short term benefits only (d) Has very large investment
20. In capital budgeting, sunk cost is excluded because it is :
(a) Of Small Amount (b) Not Incremental
(c) Not Reversible (d) All of these
21. Saving in respect of a cost is treated in capital budgeting as :
(a) An Inflow (b) An Outflow
(c) Nil (d) None of these
[Ans. : 1. (a), 2. (a), 3. (c), 4. (b), 5. (d), 6. (d), 7. (a), 8. (d), 9. (b), 10. (d), 10. (d), 11. (d), 12. (c), 13. (c),
14. (c), 15. (b), 16. (c), 17. (c), 18. (b), 19. (c), 20. (b), 21. (a).]
(C) Fill in the blanks :
1. .............technique is more an indicator of liquidity than of profitability.
2. Capital budgeting decisions are.............in nature.
3. Net cash flow is on.............basis.
4. Capital budgeting is a part of.............
5. Only the best project is selected in case of.............proposals.
[Ans. : 1. Pay-back, 2. reversible, 3. after tax, 4. Investment decisions, 5. Mutually exclusive.

☞ SHORT ANSWER TYPE QUESTIONS

1. What do you understand by capital budgeting ?
2. Discuss the objectives of capital budgeting.
3. What is the importance of capital budgeting ?
4. Discuss the pay-back period method of capital budgeting appraisal.
5. What is average return method of capital budgeting ?
6. Discuss net present value method of capital budgeting.
7. What is internal rate of return method ?
8. What is project appraisal and feasibility ?
9. Discuss the various kinds of projects.

☞ LONG ANSWER TYPE QUESTIONS

1. What is Capital Budgeting ? Examine its need and importance.
2. Explain the concept of Capital Budgeting. What are its practical utilities ?
3. What is Capital Budgeting ? What is its significance for a firm ?
4. Explain the nature and concept of Capital Budgeting.
5. What is Capital Budgeting ? Explain the different types of Capital Expenditure ?
6. Explain the nature and concept of Capital Budgeting. What are the processes of Capital Budgeting ?
7. Explain the objects and limitations of Capital Budgeting.
8. What is Capital Budgeting ? Explain the factor affecting the capital expenditure.
9. What do you mean by capital expenditure control ? Explain the steps of control of capital expenditure.
10. Write a detail note on control on capital expenditure.
11. Explain the concept of Pay-back Method. Why it is popular among the businessmen ? What are its limitations ?
12. Discuss how capital requirements are estimated in a business.
102 Financial Management

13. Explain clearly the Pay-back Period Method of evaluating alternative capital expenditure decisions.
14. What is Present Value Method ? How is profitability of various capital projects are evaluated under this method ?
What are its advantages and disadvantages ?
15. Compare ‘internal rate of return with net present value’ as meant of project assessment.
16. What do you understand by Capital Budgeting ? Explain with example the pay-back period for the determination
of the profitability of proposed Capital Investment.
17. What is Project ? Discuss the different kinds of projects.
18. What do you understand by appraisal of project ? What informations are required for such appraisal ?
19. Explain the techniques used in measuring the profitability of projects.
20. What do you understand by Feasibility ? What are various aspects of a Project Feasibility ? Explain them with
examples.

☞ PRACTICAL QUESTIONS
SHORT NUMERICAL QUESTIONS
Pay back Period
1. If the cost of a project is ` 3,00,000 and the firm receives a net annual cash flow of ` 1,20,000. Find out the pay
back period.
[Ans. 2 years 6 months]
2. A project cost ` 1,00,000 and yields annually profit of ` 30,000 after depreciation @ 10% p.a. but before tax of
50%. Calculate the pay back period.
[Ans. Pay back period = 20 years]
3. Find out the pay back and post pay back period for machine X :
Year : 1 2 3 4 5
Cash flow : 40,000 50,000 20,000 30,000 15,000
Initial Cost was ` 1,10,000
[Ans. Pay-back Period = 3 years, Post Pay-back Method = ` 45,000]
ARR
4. A project costs 50,000 and its income for last five year are : ` 5,000, ` 15,000, ` 10,000, ` 20,000 and ` 10,000.
Its average investment is ` 30,000. Calculate the accounting rate for the project.
[Ans. Average rate of return on initial investment = 24%
Average rate of return on initial investment = 40%]
5. Calculate net present value of machine A :
Year : 1 2 3 4 5
Cash Flow : 10,000 5,000 10,000 2,500 5,000
Discount @ 10% : 0.909 0.826 0.757 0.683 0.621
Initial Investment : ` 15,000
[Ans. ` 10,543]
LONG NUMERICAL QUESTIONS
1. Pay-back Period Method and Improvement
1. The management of a Manufacturing Co. proposes to invest ` 1,50,000 in a project which will give earning for
six years as follows :
Year `
1 45,000
2 30,000
3 30,000
4 27,000
5 27,000
6 18,000
Find out Pay-back Period.
[Ans. : 4 years and 8 months.]
2. There are two projects P and Q, each project requires an investment of ` 2,50,000. You are required to rank these
projects according to the Pay-back Period Method from the ahead information :
Capital Budgeting 103

Net Profit before Depreciation and after Tax

Year Project P Project Q
` `
1 12,500 25,000
2 25,000 50,000
3 50,000 75,000
4 62,500 1,00,000
5 1,00,000 —
[Ans. : Project Q. I., Project P II
P.B.P. = 4 years P.B.P. = 5 years]
3. The following is the summary of the important financial data in respect of 5 independent investment proposals :
Proposals Initial Outlay Annual Cash-flow
` `
A 25,000 5,000
B 6,750 2,250
C 14,000 3,000
D 17,500 5,000
E 15,938 1,250
Rank the above proposals according to Pay-back Period Method.
[Ans. : B—I, D—II, C—III, A—IV, E—V.]
4. Monika Ltd. is considering the purcahse of a new machine for its expansion programme. There are two possible
machines suitable for the purpose. Their details are as follows :

Particulars Machine A Machine B

` `
Capital Cost 75,000 75,000
Sales 1,25,000 1,00,000
Cost of Production :
Direct Materials 10,000 12,500
Direct Labour 12,500 7,500
Factory Overheads 15,000 12,500
Administrative Overhead 5,000 2,500
Selling and Distribution Cost 2,500 2,500
The economic life of machine A is 5 years and 4 years of machine B. The scrap value of ` 7,500 and ` 5,000
respectively.
Sales are expected to be at the rates shown for each year during the full economic life of the machines. The costs
relate to annual expenditure resulting from each machine.
Tax to be paid at 50% of the net earnings of each year. Interest on capital has to be paid at 10% p.a.
Show which machine would be the most profitable investment on the Pay-back Period Method ?
[Ans. : Pay-back Period—Machine A : 1.7 years, Machine B : 2.1 years. So, machine A should be preferred.]
5. Kamla Ltd. is considering to purchase a machine. Two machines A and B are available at the cost of ` 60,000
each. Earning after tax but before depreciation are expected as ahead :
Cash Inflows
Year
Machine A Machine B
` `
1 25,000 10,000
2 20,000 15,000
3 15,000 25,000
4 10,000 20,000
5 10,000 20,000
104 Financial Management

Evaluate the two alternatives by using :

(1) A Pay-back Period Method and
(2) Post-pay-back Period Method.
[Ans. : I. Pay-back Period Method :
Machine A—3 years (preferred) Machine B—3.5 years
II. Post pay-back Period Method :
Machine A = ` 20,000, Machine B = ` 30,000 (Preferred)
6. The following information related to project ‘X’ :
Cost ` 3,60,000
Economic Life 10 years
Annual Cash Inflow ` 30,000
Salvage value at the end of first year is ` 2,40,000. Annual decrease in the salvage value from the second year
and onwards ` 30,000. Find out the Bailout Pay-back Period.
[Ans. : 3 years]
7. Calculated discounted Pay-back Period from the following conditions :
(i) Ignoring interest factor
(ii) Taking into account interest factor at 10%.
Cost of Project ` 15,00,000
Life of the Project 5 years
Annual Cash Inflow ` 5,00,000
Present Value factor at 10% are :
Year : 1 2 3 4 5
P.V.F. : 0.909 0.826 0.751 0.683 0.621
[Ans. : PBP (Ignoring Interest) : 3 Years
PBP (Taking into Account Interest @ 10% 3 Years and 9 Months)]
2. Average Return Rate Method or Financial Statement Method
8. A project costs ` 75,000 and has a scrap value of ` 15,000. Its stream of income before depreciation and taxes
during the first year through five years ` 15,000; ` 18,000; ` 21,000; ` 25,000 and ` 29,000. Assume a 50% tax
rate and depreciation on straightline basis. Calculate the accounting rate for the project.
[Ans. : (1) Average Rate of Return on Initial Investment = 6.4%
(2) Average Annual Income After Tax = ` 4,800.
(3) Average Rate of Return on Average Investment = 10.67%
(4) Average investment = ` 45,000]
Average Annual Income
[Hint : (1) ARRI = ´ 100
Initial Investment
Average Annual Income
(2) ARRAI =
Average Investment
Initial Investment + Scrap Value
(3) AI = ]
2
9. For each of the following, compute Average Return on Investment and Average Return on Average Investment :
I. Initial Investment ` 3,60,000
Annual Cash-flow ` 35,000
Economic Life 10 yrs.
Scrap Nil
II. Initial Investment ` 6,00,000
Annual Cash-flow (After Tax and Depreciation) ` 70,000
Economic Life 10 yrs.
Scrap ` 3,20,000
III. Initial Investment ` 3,20,000
Annual Cash-flow (After Tax and Depreciation) ` 35,000
Economic Life 10 yrs.
Scrap ` 80,000
[Ans. Ist Method : Average Rate of Return on Initial Investment
I = 9.72%, II = 11.67%, III = 10.94%
Capital Budgeting 105

IInd Method : Average Rate of Return on Average Investment

I = 19.44%, II = 23.33%, III = 17.5%]
Initial Investment
[Hint : (1) Average Investment =
2
(if there is no salvage or scrap value)
Initial Investment + Scrap Value
(2) Average Investment = ]
2
10. Two projects A and B are before consideration on the management of Tinku Ltd. The particulars available are :
Project A Project B
Cost ` 1,00,000 ` 1,00,000
Estimated Life 4 yrs. 5 yrs.
Earning before Dep.
Year 1 40,000 10,000
2 30,000 25,000
3 30,000 40,000
4 20,000 50,000
5 — 50,000
Which project should be preferred ?
[Ans. : Ist Method : Rate of Return on Initial Investment : A = 5%, B = 15%
IInd Method : Rate of Return on Average Investment : A = 10%, B = 30%]
Average Annual Earning – Dep. (annual)
Hint : (1) ROI = ´ 100
Initial Investment
(2) AI = Initial Investment 2
So, Project B would be preferred.
3. Net Present Value Method
11. The management of Tata Co. Ltd. wants to invest ` 1,00,000 in a project will give earning for five years as
follows :
Year 1 2 3 4 5
Earnings 25,000 50,000 50,000 25,000 12,500
Please suggest management whether this project is worth while to be taken, if management has suggested 10%
discount rate for the computation of present value.
The discount factors at 10% are :
Year 1 2 3 4 5
Factor 0.909 0.826 0.751 0.683 0.621
[Ans. : NPV = ` 26,412.50, So, it should be preferred.]
Hint : NPV = PV – Investment.
12. Heera Ltd. is considering the purchase of a machine. The machine A and B are available each costing ` 60,000.
A discount rate of 8% is to be used. Earning after taxation are expected to be as follows :
Cash Inflows
Year
Machine A Machine B
` `
1 15,000 10,000
2 20,000 25,000
3 20,000 20,000
4 15,000 20,000
5 10,000 5,000
Indicate which machine would be a more profitable investment ? Discounting factor @ 8% are :
Year 1 2 3 4 5
Factor 0.926 0.857 0.794 0.735 0.681
[Ans. : NPV—Machine A = ` 4,745, Machine B = ` 4,670
So, Machine A is more profitable.]
106 Financial Management

4. Internal Rate of Return Method

13. Calculate Internal Rate of Return for the project ‘A’. The details of the project are as follows :
Initial Investment ` 31,500
Cash Inflows :
Year 1 2 3 4
` 6,000 9,000 12,000 15,000
Discount factors at 10% and 12% are as follows :
Year 1 2 3 4
Factor at 10% 0.909 0.826 0.751 0.683
Factor at 12% 0.893 0.797 0.712 0.636
[Ans. : Actual Rate of Internal Return = 10.84%]
Residue of LDR
[Hint : Actual Rate (r) = LDR + ´ (HDR – LDR)
Residue of LDR – Residue of HDR
See Illustration 20.]
5. Capital Budgeting Under Risk and Uncertainity
14. There are two projects A and B. Each involves an investment of ` 40,000. The expected cash inflows and the
certainity co-efficient are as under :
Project A Project B
Year Cash Inflows Certainity Cash Inflows Certainity
` Co-efficient ` Co-efficient
1 25,000 0.8 20,000 0.9
2 20,000 0.7 30,000 0.8
3 20,000 0.9 20,000 0.7
Risk-free cut-off rate is 10% : Discount factors at 10% are :
Year 1 2 3
Factor 0.909 0.826 0.751
Suggest which of the two projects should be preferred ?
[Ans. : NPV = Project A = ` 3,262, Project B = ` 6,700
So, Project B should be preferred.]
15. Heera Ltd. is considering to purchase machine A and B each costing ` 2,00,000. Earning after taxation are
expected to be as follows :
Cash Inflows
Year
Machine A Machine B
` `
1 60,000 20,000
2 80,000 60,000
3 1,00,000 80,000
4 60,000 1,20,000
5 40,000 80,000
Evaluate the two alternatives according to the following methods :
(1) Pay-back Period Method,
(2) Return on Investment Method and
(3) Net Present Value Method
A discount rate of 10% is to be used.
The discounting factors at 10% are :
Year 1 2 3 4 5
Factor 0.909 0.826 0.751 0.683 0.621
[Ans. : I. PBP Method :
Machine A = 2 years 7 months, Machine B = 3 years 4 months
So, Machine A will be preferred.
II. Return on Investment Method :
Machine A = 28%, Machine B = 32% (Profitable)
Capital Budgeting 107

III. Present Value Return on Investment Method :

NPV = Machine A = ` 61,540 (Profitable), Machine B = ` 59,460]
16. The Great Maratha Ltd. is considering projects for capital expenditure. They have only ` 2,00,000 for
investment. The following proposals have been submitted :
Project Investment Cash-Flow Life in Years
` `
1 60,000 12,000 10
2 1,60,000 40,000 20
3 1,50,000 50,000 10
4 56,000 8,000 15
If the cost of capital is 20%. Please recommend (Rank) projects according to :
(1) Pay-back Period Method, (2) Rate of Return Method,
(3) Present Value Index Method.
Present Value factors at 20% are :
P. V. Factor 4.192 4.870 4.192 4.675
Project 1 2 3 4
Life in Years 10 20 10 15
[Ans. : Ranking of Projects :
I. Pay-back Method : Project 1 = III, 2 = II, 3 = I, 4 = IV
II. Rate of Return Method : Project 1 = III, 2 = II, 3 = I, 4 = IV
III. Present Value Index Method : Project 1 = III, 2 = III, = I, 4 = IV]
17. On the basis of appropriate calculation, indicate which one of the following cars should be purchased by a
taxi-driver.
Car A Car B
` `
Initial Costs 60,000 70,000
Cash Inflows :
Year 1 40,000 30,000
2 36,000 36,000
3 20,000 24,000
The prevailing rate of interest is 9%.
Discount factors at 9% are :
Year 1 2 3
Factor 0.917 0.842 0.772
[Ans. 1. PBP Method : Car A = 1 year 7 months (Preferred); Car B = 2 years 2 months
2. P. P. Back Period Method : Car A = ` 36,000 (Preferred); Car B = ` 20,000
3. Profitability Index Method : Car A = 137.39% (Preferred); CAr B = 109.07%]
18. No project is acceptable unless the yield is 10% cash inflows of a certain project alongwith cash outflows are
given below :
Years Outflows Inflows
` `
0 3,00,000 —
1 60,000 40,000
2 60,000
3 1,20,000
4 1,60,000
5 60,000
The salvage value at the end of 5th year is ` 80,000. Calculate Net Present Value. Discount factors at 10% are :
Year 0 1 2 3 4 5
Factor 1 0.909 0.826 0.751 0.683 0.620
[Ans. : PV = ` 3,54,540 (outflows), NPV = ` 17,580.]
108 Financial Management

19. A Company has to select one of the following two projects :

Project A Project B
` `
Cost 11,000 10,000
Cash-Inflows :
Year 1 6,000 1,000
Year 2 2,000 1,000
Year 3 1,000 2,000
Year 4 5,000 10,000
Using the Interest Rate of Return Method, Suggest which project is preferable ?
PV Factor
Year 1 2 3 4
10% .909 .826 .757 .683
12% .893 .797 .712 .636
14% .877 .769 .675 .592
15% .870 .756 .658 .572
[Ans. : IRR-Project A : 11.27%, Project B : 10.23%.]
20. A machine purchased six years ago for ` 3,00,000 has been depreciated to a book value of ` 1,80,000. Its
economic life was 15 years with no salvage value. If this machine is replaced by a new machine costing `
4,50,000, the operating costs would be reduced by ` 60,000 for the next 10 years. The old machine could also be
sold for ` 1,00,000. The cost of capital is 10%. The new machine will be depreciated on straight line basis over
an eight years life with ` 50,000 as salvage value. The company's tax rate is 55%. Using N.P.V. method, state
whether the old machine should be replaced. PV Factor @ 10%.
Year 1 2 3 4 5 6 7 8
Factors .909 .826 .751 .683 .621 .564 .573 .467
[Ans. : Annual Cash Inflows : ` 43,500, Net Present Value = ` (–) 50,621.00.]
21. A choice is to be made between two competing projects, which require an equal investment of ` 50,000 each and
are expected to generate net cash-inflows as under :
End of the Year Project I (Project II)
` `
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%. Using discounted cash-flow method or NPR method recommend
which proposal is to be preferred.
PV Factor @ 10%
Year 1 2 3 4 5 6
Factors .909 .826 .751 .683 .621 .564
[Ans. : NPV = Project I = 3,461 and Project II = 6,819.]
22. Rama Ltd. is planning to purchase a machine for ` 1,50,000 which is likely to generate the following earnings in
the next five years :
Year : 1 2 3 4 5
EBDT (`) : 50,000 55,000 60,000 62,000 65,000
The purchase of machine would result in an increase of working capital by ` 15,000. The machine will be
depreciation on straight line method and will have a salvage value of ` 25,000. Corporate tax rate is 50%. Should
the machine be purchased if the cost of capital is 12%. Use net present value method. PV Factor @ 12%.
Year 1 2 3 4 5
Factors .893 .797 .712 .636 .567
[Ans. : Total Present Value = ` 1,71,488.50, Net Present Value = ` 6,488.50.]
Capital Budgeting 109

23. Cost of investments ` 20,000. Economic life 5 years. Cash inflows ` 8,000 each for five years. Cost of capital
may be taken at 10%. Cash inflows may be reinvested at the following expected rates of return :
Year end Rate
1 6%
2 6%
3 8%
4 8%
5 8%
Using Terminal Value method, evaluate the proposal.
Compounding Factor
Year 0 1 2 3 4
Rate of Return 8% 8% 8% 6% 6%
Value 1.000 1.080 1.166 1.191 1.262
PV Factor 5th @ 10% = 0.621
[Ans. Present Value of Compounded Cash Inflows = ` 28,312.63.]
24. From the following informations, calculate Net Present Value of the two projects and suggest which of the two
projects should be accepted assuming a discount rate of 10%.
Project X Project Y
` `
Initial Investment 20,000 30,000
Estimated Life 5 yrs 5 yrs
Scrap Value 1,000 2,000
The profits before depreciation and after taxes (cash inflow) are as under :
Year I Year II Year III Year IV Year V
` ` ` ` `
Project X : 5,000 10,000 10,000 3,000 2,000
Project Y : 20,000 10,000 5,000 3,000 2,000
Discounting factor at 10% :
Year : I II III IV V
Factor : 0.909 0.826 0.751 0.683 0.621
[Ans. : Net Present Value : Project X = ` 4,227, P.I. = 0.221, Project Y = ` 4,728, P.I. = 0.158]
Thus, Project X should be accepted.
25. The capital budgeting department of a company has suggested three investment proposals. The after tax
cash-flows for each are tabulated below. If the company's cost of Capital is 12%, rank them in order of
profitability :
After Tax Cash-flow
Year Project A Project B Project C
` ` `
0 – 20,000 – 60,000 – 36,000
1 5,600 12,000 13,000
2 6,000 20,000 13,000
3 8,000 24,000 13,000
4 8,000 32,000 13,000
P.V.F. at 12% :
Year : 1 2 3 4
P.V.F : 0.893 0.797 0.712 0.636
[Ans. : P.I. on the basis of P.V. : Rank
Project—A : 1028—III, Project B : 1068—II, Project C : 1097—I]
Note : P.I. = Profitability Index
26. The following details relate to two mutually exclusive projects A and B having unequal expected lives :
A B
` `
Initial Outlay 20,000 40,000
Cash InFlow After Tax :
Year 1 16,000 16,000
110 Financial Management

2 14,000 18,000
3 — 14,000
4 — 12,000
Required Rate of Return is 10%. Which project should be preferred by N.P.V. Method ?
PV @ 10%

Year 1 2 3 4
Factors .909 .826 .751 .683

[Ans. : N.P.V. = Project—A = ` 11,168, Project—B = ` 8,122.]

27. Rohtas Industries, Ghazipur is planning the acquisition of a machine. Two machines X and Y are available each
costing ` 50,000. In comparing the profitability of the machines, a discount rate of 10% is to be used. Earnings
after tax and before dep. are expected to be :
X Y
` `
1st year 15,000 5,000
2nd year 20,000 15,000
3rd year 25,000 20,000
4th year 15,000 30,000
5th year 10,000 20,000
Find out which would be more profitable investment. You may use Discounted Pay-back Period and Net Present
Value Method. P.V.F. at 10% for five years are :
Year : 1 2 3 4 5
P.V.F. : 0.909 0.826 0.751 0.683 0.621
[Ans. : PV : X = ` 65,385, Y = ` 64,865; NPV : X = ` 15,385, Y = ` 14,865;
Pay-back Period : X = 3 years 1.2 months, Y = 3 years 10.5 months]
28. Given : `
Initial Investment 20,000
Net Cash Inflow :
Ist year 2,000
IInd year 2,000
IIIrd to 10th year 2,500
Work out Net Present Value with a discount rate at 10% and express whether the investment will be worthwhile.
The P.V.F. at 10% are :
Years : 1 2 3 4 5 6 7 8 9 10
P.V.F. : 0.909 0.826 0.751 0.683 0.621 0.565 0.513 0.467 0.424 0.386
[Ans. : NPV = 5,505.]
29. A machine with a useful life of 5 years is to be acquired at a total cost of ` 3,00,000. The cash inflow from it
over the five years period will total ` 4,00,000 distributed as follows :
Years : 1 2 3 4 5
Cash Inflow : 1,10,000 1,00,000 80,000 60,000 50,000
(i) At what rate must the annual cash inflow be discounted so that years total of the present value will equal
` 3,00,000 the cost of investment.
(ii) If the cost of capital is 10%, calculate the net present value and profitability index. P.V.F. at 10%, 12% and
13% are given as under :
Year : 1 2 3 4 5
P.V.F. 10% : 0.909 0.826 0.751 0.683 0.621
P.V.F 12% : 0.893 0.797 0.712 0.636 0.567
P.V.F. 13% : 0.885 0.783 0.693 0.613 0.543
Capital Budgeting 111

[Ans. : NPV IRR

10% = 14,700 (i) 12.22%
12% = 1,400 (ii) 1.049%
13% = – 4,980]
30. On the basis of appropriate calculation, indicate which one of the following car's should be purchased by a taxi
driver :
Car A Car B
` `
Initial Costs 3,00,000 3,50,000
Cash Inflows :
1 2,00,000 1,50,000
2 1,80,000 1,80,000
3 1,00,000 1,20,000
The prevailing rate of interest is 9%. P.V.F. at 9% are : 0.917, 0.842 and 0.722.
[Ans. : (i) Payback Period A = 1 year 7 months, B = 2 years 2 months
(ii) NPV : A ` 1,12,160, B = ` 31,750]
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