FMP: Capital Budgeting

Q No.1
A firm invested cash Rs.200,000 on a project. It is forecasted that following cash flow
will generate by this project in coming 5 years. Firm cost of capital is 2!.
"ear #ash Inflow
1 Rs. 50,000
2 50,000
3 75,000
4 125,000
5 75,000
Re$%ried& 'se above information to calc%late
Payback period
Discounted payback period
NPV
Profitabiity !nde"
!RR
#!RR
Q 2:
(") #o. *td is considering the p%rchase of one of the following machines, whose
relevant data are given below&
+achine ( +achine "
,stimated *ife - years - years
#apital #ost Rs..0,000 Rs..0,000
,arning /after ta01&
"ear
2
-
20,000
50,000
20,000
20,000
30,000
50,000
4he company follows the straight line method of depreciation5 the estimated salvage
val%e of both the types of machines is 6ero.
7how net present val%e of each machine ass%ming a 0! cost of capital.

Q 3&
A company is considering two m%t%ally e0cl%sive proposals, ( and ".
8roposal ( will re$%ire the initial cost of Rs.20, 000 with no salvage val%e, and will also
re$%ire an increase in the level of inventories and receivables of Rs.90,000 over its life.
4he project will generate additional sales of Rs.-0,000 and will re$%ire cash e0penses of
Rs.20,000 in each of its 5 year life. It will be depreciated on straight line method.
8roposal " will re$%ire an initial capital of Rs.200,000 with no salvage, and will be
depreciated on straight line basis. 4he earnings before depreciation and ta0es d%ring its 5
year life are&
"ear "ear 2 "ear - "ear 2 "ear 5
Rs. 30,000 Rs.39,000 Rs.:0,000 Rs..0,000 Rs..2,000
4he company has to pay corporate income ta0 at the rate of 20!, and is eval%ating
projects with 0! as the cost of capital.
/i1 ;hich of the project is acceptable %nder the net present val%e method<
/ii1 ;ill it ma=e any difference to the above decision if profitability inde0 is
employed<
> ?o.2
"o%r feasibility re$%ire land which yo% bo%ght at Rs..2 million on @ctober 0, 2005 and
yo% will pay in Aecember 2005. "o% plan to constr%ct a b%ilding on this land and
estimate that 2 million will be paid in 2009 and 2 million will be paid in 2003. ,$%ipment
will be re$%ired in 2003 and estimated cost for this e$%ipment will be 0 million.
8roject also re$%ires an initial investment in net wor=ing capital e$%al to 2! of the
estimated sales in the first year. 4his investment will be made in Aecember 2003 and this
wor=ing capital will also be re$%ired to increase every year by 2! of any sales increase
e0pected d%ring the year. 4he project estimated economic life is 9 years. At that time,
the land is e0pected to have a mar=et val%e of .3 million, the b%ilding a val%e of .0
million and the e$%ipment a val%e of 2 million.
+ar=eting department e0pect sales for 200: wo%ld be 25000 %nits and price set for this
year is Rs. 2200 per %nit. 4he prod%ction department has estimated that variable
man%fact%ring costs wo%ld total 95! of sales val%e and fi0ed overhead costs, e0cl%ding
depreciation wo%ld be Rs.: million for the first year of operation. 7ales prices and fi0ed
overhead costs are e0pected to increase by 9! per year.
4a0 rate is 20!. Ass%me cash flow will occ%r at the end of every year. Also ass%me that
company %ses diminishing balance method/ rate 5!1 for e$%ipment and 5! for b%ilding
depreciation.
2
Q 5:
AB# *td man%fact%res toys and other short lived fad items. 4he research and
development department has come %p with an item that wo%ld ma=e a good promotional
gift for office e$%ipment dealers. As a res%lt of efforts by the sales personnel, the firm has
commitments for this prod%ct.
4o prod%ce the $%antity demanded, AB# *td will need to b%y additional machinery and
rent additional space. It appears that abo%t 25,000 s$%are feet will be needed5 2,500
s$%are feet of presently %n%sed space, b%t leased at the rate of Rs.- per s$%are foot per
year, is available. 4here is another 2,500 s$%are feet adjoining the AB# facility
available rent of Rs.2 per s$%are foot.
4he e$%ipment will be p%rchased for Rs..00, 000. It will re$%ire Rs.-0,000 in
modifications, Rs.90,000 for installation and Rs..0,000 for testing. 4he e$%ipment will
have a salvage val%e of abo%t Rs.:0, 000 at the end of the third year. ?o additional
general overhead costs are e0pected to be inc%rred.
4he estimates of reven%es and costs for this prod%ct for the three years have been
developed as follows&
8artic%lars "ear "ear 2 "ear -
7ales Rs.0,00,000 Rs.20,00,000 Rs.:,00,000
*ess #osts&
+aterial, *abor and
overhead inc%rred
200,000 350,000 -50,000
@verhead allocated 20,000 350,000 -5,000
Rent 50,000 50,000 50,000
Aepreciation -00,000 -00,000 -00,000
4otal #osts 3.0,000 ,35,000 3-5,000
,arning before ta0es 20,000 :25,000 95,000
*ess ta0es :2,000 --0,000 29,000
,arning after ta0es 29,000 2.5,000 -5,000
If the company sets a re$%ired rate of ret%rn of 20! after ta0es, sho%ld this project be
accepted<
-
Q 6:
A company owns a machine which is in c%rrent %se. It was p%rchased for Rs.90, 000
and had a projected life of 5 years with Rs.0, 000 salvage val%es. It has been
depreciated straight line for 5 years to date, and can be sold for Rs.-0, 000. A new
machine can be p%rchased at cost of Rs.290, 000. It will have a 0 years life, salvage
val%e of Rs.0, 000, and will be depreciated straight line. It is estimated that the new
machine will red%ce labor e0penses by Rs.5, 000 per year and net wor=ing capital
re$%irement by Rs.20, 000. 4he income ta0 rate of the company is 20! and its re$%ired
rate of ret%rn is 2! on investment. Aetermine whether the new machine sho%ld be
p%rchased. 4he income statement for the firm %sing the c%rrent machine for the c%rrent
year is as follows&
7ales Rs.20,00,000
*abor Rs.300,000
+aterial 500,000
Aepreciation 200,000
4otal #ost 200,000
,arning before ta0 900,000
Income ta0 --0,000
After ta0 profit 230,000
2