Chapter 2: CAPITAL BUDGETING

1. Shilpa Co. Ltd. is considering investing in a proposal Costing ₹50,000. Its estimated life is 4 years. The
following are the earnings before depreciation and taxes.
YEAR 1 2 3 4
EBDT 16,000 18,000 25,000 30,000
Evaluate the proposal under, a) Payback period b) NPV at 10% c) ARR d) PI
Discount factors at 10% are 0.909, 0.826, 0.51, and 0.683.

2. X Company is considering buying a machine. Two machine alternatives are available costing ₹1,00,000. The
cost of capital is 10%. Each machine has a life of 5 years. The cash inflows after Taxation are
YEAR 1 2 3 4 5
MACHINE A 30,000 40,000 50,000 30,000 20,000
MACHINE B 50,000 40,000 30,000 20,000 20,000
Recommended the best machine under A) Payback period B) NPV C) PI D) ARR
Discount factors at 10% are 0.909, 0.826, 0.751, 0.683, 0.621

3. B Ltd. is considering investing in a project that costs ₹6,00,000. Tax rate of the Co. is 30%, company uses
straight line method of depreciation. The proposed cash flows before tax and depreciation is as follows.
YEAR 1 2 3 4 5
CFBT(₹) 150,000 125,000 150,000 200,000 275,000
Determine: i. NPV at 10% ii. Profitability index at 10% iii. ARR iv. Payback period.
Discount factors at 10% are
YEAR 1 2 3 4 5
PV FACTOR 0.909 0.826 0.751 0.683 0.621

4. A company is considering an investment proposal to purchase a machine costing ₹2,50,000. The machine
has a life expectancy of 5 years and no salvage value. The company‟s tax rate is 40%. The firm uses straight
line method of providing depreciation. The estimated Cash Flows Before Tax (CFBT) from machine are as
follows:
YEAR 1 2 3 4 5
CFBT(₹) 110,000 120,000 140,000 150,000 200,000
i. Payback period ii. Average rate of return iii. Net present value at 10% iv. Profitability Index at 10%.
Discount factors at 10% are
YEAR 1 2 3 4 5
PV FACTOR 0.909 0.826 0.751 0.683 0.621

5. X Ltd. is considering the purchase of a machine. Two machines are available. E and F. The cost of each
machine is ₹60,000. Each machine has an expected life of 5 years. Net profit before tax during the expect life
of the machine are given below.
YEAR 1 2 3 4 5 TOTAL
MACHINE E 15,000 20,000 25,000 15,000 10,000 85,000
MACHINE F 5,000 15,000 20,000 30,000 20,000 90,000
Following the method of return on investment, ascertain which of the alternatives will be more profitable.
The average rate of tax may be taken at 50%.

6. Modern Electronics Co. Ltd is considering the purchase of a machine. Two machine A and B are available,
each costing ₹50,000. In comparing the profitability of these machines a discount rate of 10% is to be used.
Earning after taxation is expected to be as follows:
YEAR 1 2 3 4 5
MACHINE A 15,000 20,000 25,000 15,000 10,000
MACHINE B 5,000 15,000 20,000 30,000 20,000
You are also given the following data: Years hence Present value of Re.1 at 10% discount
YEAR 1 2 3 4 5
PV FACTOR 0.909 0.826 0.751 0.683 0.621
Evaluate the proposals using: The net present value and profitability index.

7. Modern Company Ltd., is considering the purchase of a machine which costs ₹50,000. The machine has a life
expectancy of 5 years and no salvage value. The tax rate is 35%. Assume the Co. uses straight line method of
depreciation. The estimates Cash Flows Before Tax (CFBT) from the investment are as follows:
YEAR 1 2 3 4 5
CFBT(₹) 10,000 10,692 12,769 13,462 20,385
Compute the following:
i. Payback period. ii. Average rate of return.
iii. NPV at 10% discount rate. iv. Profitability index at 10% discount rate.
The PV of Re. 1 and 10% discount rate from year 1 to 5 are: 0.909, 0.826, 0.751, 0.683 and 0.621.
8. In Conglomerate Ltd. expects cash inflows from its investment proposal it has under- taken in time period
zero, ₹2,00,000 and ₹1,50,000 for the first two years respectively and then expects annuity payment of
₹1,00,000 for the next eight years, what would be the net present value of cash inflows assuming a 10 per
cent rate of interest ?
YEAR 1 2 3 4 5 6 7 8
PV FACTOR 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467

9. Self sufficient Ltd. is planning to invest in a project that costs ₹4,00,000. Tax rate is 55%. The company uses
straight line method of depreciation. The proposed projects cash flow before tax is as follows:
YEAR 1 2 3 4 5
CFBT(₹) 100,000 100,000 150,000 150,000 250,000
Determine
i. Payback period ii. Average rate of return
iii. NPV at 15% iv. Profitability index at 15%
Discount factors at 15% are
YEAR 1 2 3 4 5
PV FACTOR 0.870 0.756 0.658 0.572 0.497

10. M/s. Rex Industries is considering purchasing a machine. Two machines A & B are available cash costing
₹50,000. The cost of capital is 10%. Each machine will have a life of 5 yearsThe cash inflows after taxation
are expected to be as follows:
YEAR 1 2 3 4 5
MACHINE A 15,000 20,000 25,000 15,000 10,000
MACHINE B 25,000 20,000 15,000 10,000 10,000
You are required to evaluate each of the above projects and recommended the project under the
following methods.
i. Payback period ii. Accounting rate of return iii. NPV iv. Profitability Index
The discount factor at 10% is:
YEAR 1 2 3 4 5
PV FACTOR 0.909 0.826 0.751 0.683 0.621

11. Manish Motors Ltd. has an investment opportunity costing ₹4,00,000 with the following respective net cash
flows after tax before depreciation.
Year 1 2 3 4 5 6 7 8 9 10
Cash flows 70,000 70,000 70,000 70,000 70,000 80,000 100,000 150,000 100,000 40,000
Using 10% as the cost of capital determine the following:
i. Payback period
ii. NPV at 10% discount factor
iii. PI at 10% discount factor
iv. IRR with the help of 10% and 15% discount factor
YEAR 1 2 3 4 5 6 7 8 9 10
PVF @10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386
PVF @15% 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247
Should the company accept this investment?

12. A company is considering the purchase of a new machine which will replace some operations. There are
two alternative machines X and Y. From the following information prepare profitability table and find
out payback period and ARR.
Particulars X Y
Cost of the machine 150,000 250,000
Estimated life 5 years 5 years
Cost of Indirect material 6000 8000
Estimated savings in scrap 10000 15000
Additional cost of maintenance 19000 27000
Estimated savings in direct wages:
i) Employees not required 15 20
ii) Wages per employee 6,000 6,000
Tax rate 50% 50%
13. No project is acceptable unless the yield is 10%. Cash inflow of a certain project along with cash outflows are
given below:
YEAR CASH OUTFLOWS CASH INFLOWS
0 150,000 -
1 30,000 20,000
2 - 30,000
3 - 60,000
4 - 80,000
5 - 30,000
The salvage value at the end of the 5th year is ₹40000. Calculate the NPVPV factor at 10% discount is as
follows:
YEAR 1 2 3 4 5
PV FACTOR 0.909 0.826 0.751 0.683 0.621

14. A company has installed a machine two years ago costing ₹7,00,000. Balance period of life of the said
machine is 5 years
Due to technological advancement, the company is considering to replace the present machine the cost of
which is ₹14,00,000. Installation costs are estimated at ₹1,00,000.
Estimates of the inflows before depreciation and income-tax for 5 years for both the machine are given
below. Method of calculating depreciation is straight line. Rate of income-tax is assumed to be 50%
Estimates of cash inflows
YEAR PRESENT MACHINE NEW MACHINE
1 3,00,000 5,00,000
2 3,00,000 6,00,000
3 3,00,000 7,00,000
4 3,00,000 9,00,000
5 3,00,000 10,00,000
From the above data, calculate ARR, PBP, NPV at 10% and PI at 10%.

15. Ravi Kiran Ltd. is planning to start new project with following data:
Project cost ₹14 lakhs
Depreciation 12% on project cost on Straight line method
Projected annual profit after charging depreciation and all other charges, except taxation 50% rate is as
under:
YEAR 1 2 3 4 5
₹In Lakhs 4 4.5 4.8 5.2 5.4
Calculate IRR. PV of Re. 1 at 9% and 15% interest rate is as follows:
Year 1 2 3 4 5
At 9% 0.971 0.842 0.772 0.708 0.65
At 15% 0.87 0.756 0.658 0.572 0.497

16. A company has an investment opportunity costing ₹40,000 with the following expected net cash inflows
(CFATBD):
Year 1 2 3 4 5 6 7 8 9 10
Net cash inflows 7000 7000 7000 7000 7000 8000 10000 15000 10000 4000
Determine the internal rate of return with the help of the following discount factors
Year 1 2 3 4 5 6 7 8 9 10
At 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386
At 15% 0.87 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247
PROBLEMS ON CAPITAL RATIONING:
17. The following investment proposals available for the firm.
Investment Proposals 1 2 3 4
Initial Investment 300000 150000 250000 200000
PI 1.2 1.15 1.1 1.05
The available funds is ₹300000, which proposals should be accepted.

18. A firm has the following investment opportunities:

Proposal 1 2 3 4
Initial outlay 300000 150000 250000 200000
Profitability index 1.2 1.15 1.1 1.05

The available funds are ₹400000. Which proposals the firm should accept?

19. A Company has ₹ 7,00,00,000 for investment. It has evaluated its options and found that four investment
projects give Positive NPV. All investments are divisible. Advise the management which investments to
select..
Projects Investment (₹In crore) NPV (₹in crore) PI
X 3 0.6 1.2
Y 2 0.5 1.25
Z 2.5 1.5 1.6
W 6 1.8 1.3

20. A company has self-imposed capital ₹ 700000000 is trying to decide which of the following investment
proposals should be undertaken by it. All these investments are indivisible and independent. You have been
given with the NPV of the projected cash flows:
Projects A B C D E
Investment (₹ in crore) 10 24 32 22 18
NPV (₹ in crore) 6 18 20 30 20

21. Glaxo ltd provides you the following information

a) Profit after tax before depreciation for 5 years.
Year 1 2 3 4 5
Profit after tax before depreciation 25,000 45,000 55,000 1,65,000 1,95,000
b) Investment ₹3,00,000.
c) Present value factor at 11% and 13% given below
P.V @ 11%: 0.901, 0.812, 0.731, 0.659, 0.593
P.V @ 13%: 0.885, 0.783, 0.693, 0.613, 0.543
Find out internal rate of return.

22. Nestle India has financial constraints. It has to undertake profitable projects. But project manager has
supplied with 13,00,000 to invest . All the projects are divisible. Following are the profitable projects.
Projects Investment NPV PI
A 3,00,000 1.5 1.2
B 2,00,000 1.2 1.8
C 5,00,000 1.6 1.6
D 4,00,000 1.3 1.4
E 6,00,000 1.8 1.7
Find out how many projects company can select.

23. The following details are available about a project proposal

Cost of project: 10,00,000
Life of project: 5 years
Salvage: NIL
Tax rate: 50%
Method of depreciation: straight line method
Year Cash flow before tax and before depreciation P.V.factor at 10%
1 3,00,000 0.909
2 4,60,000 0.826
3 6,20,000 0.751
4 6,80,000 0.683
5 8,00,000 0.621
Compute
a) Payback period b) Average rate of return c) Profitability index at 10%