CAPITAL BUDGETING

Pay back period

1.Project A costs Rs.200000 and Project B costs Rs.300000 . Both have 10 years of life. Uniform cash
receipts of Rs.40000 and Rs.80000 are expected annually for A and B. Salvage values are Rs.140000 and
Rs.160000 and are to decline at Rs.20000 and Rs.40000 annually for A and B.
Compute pay back period under traditional and bail out payback methods.[ans:5,3.75,2,2.25]

2 .A project costing Rs.560000 us expected to produce CFAT of Rs 80000 over a period of 15

years.Calculate payback period and estimate the IRR from the payback period.[14.28%]

Accounting rate of return

3.Cost of machinery is Rs.80000.Life of machine is 5 years. Scrap value Rs.10000 . Additional profits due
to this machine are expected as follows.
Year Profit(Rs)
1 20000
2 40000
3 30000
4 15000
5 5000

These profits are before depreciation . You are required to calculate the return on capital employed.
[Ans:10% and 17.78%]

4.Determine the ARR from the following data

Machine A Machine B

Cost 56125 56125

Annual income
After depreciation and tax
01 3375 11375
02 5375 9375
03 7375 7375
04 9375 5375
05 11375 3375

Estimated life 5 5
Estimated salvage value 3000 3000

[Ans:24.9% or 13.1%]

5.ABC ltd is considering investing in a project that costs Rs5.00 lakh. The estimated salvage value is
zero.Tax rate is 35% The company uses st line method of depreciation for tax purposes.CBFT is as follows

1 100000
2 100000
3 150000
4 150000
5 250000
Determine the Payback period and ARR
[4.18,13% or 53%]

Internal rate of return {yield on investment, marginal efficiency, time adjusted rate of return}

6. A company has to select one of the one of the following two projects
A B
Cost 11000 10000
Cash flows
01 6000 1000
02 2000 1000
03 1000 2000
04 5000 10000
Use IRR in your evaluation.
[11.27% and 10.24%]

7 The investment data for a new project are as follows.

Capital outlay Rs.200000
Depreciation 25% wdv
CFAT are as follows
1 100000
2 100000
3 80000
4 80000
5 40000

Evaluate using PB method, Rate of return on original investment and IRR using PBR
[2.0,33%]

8.A project costs Rs.36000 and is expected to generate cash flows of Rs.11200 annually for
5 years.Calculate the IRR of the project.
[16.8%]
Capital budgeting-cont,d

Net Present value

9.AB Ltd wants to purchase a plant for expanding its operations. The plant is available at Rs.3.00
lakhs in cash or Rs.4.50 lakhs are to be paid in 5 annual instalments at the end of each
year.Assuming a required return of 15 % which option should be selected.

10. The following information is available as to cash flows of a project. Assuming 10%
capital determine profitability of a project.
Rs ‘000
Year 00 01 02 03 04 05
Cash out flows 40 0 0 30 0 0
Cash inflow 0 20 20 0 40 80
[ans;49170]

11 N ltd owns a machine with the following characteristics

Book value 110000
Market value 80000
Salvage value nil (after 5 years)
Operating cost p.a 36000
Cost of capital is 15% . Tax rate is 35% . Company follows st line method of depreciation
The company is considering selling the machine. If it does so the total operating cost will increase to
Rs.76000 p.a Advise whether the machine is to be sold.[advantage not selling Rs44586]

12 BSES has decided to expand its generation capacity.Two alternative plants are available .The
information about the alternatives are as follows.
1 2
Investment 680 900
Operating cost p.a 260 150
Cost of dismantling
(at the end of 20 years) 10 10

Cost of funds is 10% . Ignore taxes. Depreciation rate is 10% st line

[2895.13,2181.57]

13 A ltd is at present purchasing an item from outside at Rs.100 per unit. The supplier has
informed that he will increase the price to Rs 125.If A starts manufacturing the item itself it has
to install a machinery worth Rs.10 lakhs. Variable cost will be Rs.30 per unit. Additional fixed
cost will be Rs 1.00 lakh p.a Tax rate is 35% and cost of capital is 15% .Company needs 7500
units of this product for next 6 years. Whether the company should produce the item itself?
[npv 633401]

14 From the following details decide which project is to be selected.

Particulars Project A Project B

Year 0 (14000 ) (25000)

Year 1-5 3000 8000
IRR 23 18
NPV 4950 5320
Profitability Index/Benefit Cost ratio

15 P is considering a new automatic blender . The new blender would last for 10 years and
would be depreciated to zero over 10 year period. The old blender would also last 10 years and
would be depreciated over 10 year period.The old blender has book value of Rs.20000 and can
be sold for Rs.30000 (original cost Rs.40000). The new blender will cost Rs.1.00 lac.
This would reduce the labour expenses by Rs.12000 . The tax rate is 50% and 30% on
capital gains.The cost of capital is 8%. Compute NPV and PI .Given value of annuity
@8% for Rs.1 for 10 years=6.710(PI=.895)
16 The capital budgeting department of a company has suggested 3 investment proposals .
The after –tax cash flow for each are tabulated here. If the cost of capital is 12% , rank
them on the basis of the PI

Year A B C
0 20000 60000 36000
1 5600 12000 13000
2 6000 20000 13000
3 8000 24000 13000
4 8000 32000 13000

[1.028,1.068,1.097]

Capital rationing
17 The total available budget for a company is Rs.20 crores and the total cost of the project
is Rs.25 crores. The project s listed below have been ranked in order of the profitability. There is
a possibility of submitting X project where cost is assumed to be Rs.13 crores and it ahs the
Profitability Index of 140
Project Cost PI
A 6 150
B 5 125
C 7 120
D 2 115
E 5 100
25

Which project including X are to be acquired by the company?

18 A company has Rs.7 crores available investments . It has evaluated its options and has
found that only 4 investment proposals given below have positive NPV.All these investments
are divisible. Advise the management as to selection of the projects.
Project Initial investment NPV PI
A 3 0.6 1.2
B 2 0.5 1.25
C 2.5 1.5 1.6
D 6 1.8 1.3
{c AND d }