Solutions on Capital Budgeting Decisions

1. A company is considering two mutually exclusive projects. Both require an initial

cash outlay of Rs. 10,000 each, and have a life of five years. The companys
required rate of return is 10 per cent and is in tax bracket of 50 per cent. The
projects will be depreciated on a straight line basis. The before tax cash flows
expected o be generated by the projects are as follows:
Before tax cash flows
Projects
1
2
3
4
5
A
4,000 4,000 4,000 4,000 4,000
B
6,000 3,000 2,000 5,000 5,000
Calculate the each project: payback period, average rate of return, net present
value, profitability index and internal rate of return.
2. A company if considering expanding its production. It can go in either for an
automatic machine costing Rs. 2,24,000 with an estimated life of 5 years or an
ordinary machine costing Rs. 60,000 having an estimated life of 8 years. The
annual sales and costs are estimated as follows:
Particulars
Automatic Ordinary
machine
Machine
Sales
1,50,000
1,50,000
Costs:
Materials
50,000
50,000
Labour
12,000
60,000
Variable overheads 24,000
20,000
Calculate payback period and average rate of return
3. A project costs Rs. 20,00,000 and yields annually profit of Rs. 3,00,000 after
depreciation at 12.50 per cent per year but before tax at 50 per cent. Calculate
payback period and suggest whether it should be accepted or rejected based on 6
year standard payback period.
4. XYZ Ltd. is considering two projects. Each project required an investment of Rs.
10,000. The firms cost of capital is 10 per cent. The net cash inflows in two
projects X and Y are as follows:
Years
1
2
3
4
5
X
5,000
4,000
3,000
1,000
-------Y
1,000
2,000
3,000
4,000
5,000
The company has fixed 3 years PBP as the cut-off point. State which project
should be accepted?

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5. A limited company has under consideration the following two projects. Their
details are as follows:
Particulars
Project X
Project Y
Investment in machinery 10,00,000
15,00,000
Working capital
5,00,000
5,00,000
Life of machinery
4 years
6 years
Scrap value of machinery 10 per cent 10per cent
Tax rate
50 per cent 50 per cent
Income before depreciation and tax at the end of the every year is as follows:
Year
1
2
3
4
5
6
X
8,00,000 8,00,000 8,00,000 8,00,000
------------Y
15,00,000 9,00,000 15,00,000 8,00,000 6,00,000 3,00,000
You are required to calculate the average rate of return and suggest which
project is to be preferred.
6. A project costs Rs. 5,00,000 and has a scrap value of Rs. 1,00,000. Its stream of
income before depreciation and taxes during first year through five years is Rs.
1,00,000, Rs. 1,20,000, Rs. 1,40,000, Rs. 1,60,000 and Rs. 2,00,000. Assume a 50
per cent tax rate and depreciation on straight line basis. Calculate the accounting
rate for the project.
7. From the following data determine the accounting rate of return:
Particulars
Machine A
Machine B
Original cost
56,125
56,125
Additional investment in working capital 5,000
6,000
Estimated life (years)
5
5
Estimated salvage value
3,000
3,000
Income tax rate
55
55
8. Calculate the NPV from the following cash streams:
Years
0
1
2
3
4
5
Cash flow 10,00,000 -------------------------Cash flow --2,00,000 200,000
3,00,000 3,00,000 3,50,000
The cost of capital of the firm is 10 per cent.
9. No project is acceptable unless the yield is 10 per cent. Cash inflows of a certain
project along with cash outflows are given below:
Years
0
1
2
3
4
5
Cash flow 1,50,000 30,000
---------------------Cash flow ---20,000
30,000
60,000
80,000
30,000
th
The salvage value at the end of 5 year is Rs. 40,000. Calculate the NPV and PI
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10. A project needs an investment of Rs. 1,38,500. The cost of capital is 12 per cent.
The net cash inflows are as follows:
Year
1
2
3
4
5
CFAT
30,000
40,000
60,000
30,000
20,000
Calculate IRR and suggest whether projects should be accepted or not.
11. Calculate IRR for the project having the following cash streams
Years
0
1
2
3
4
Cash flow 1,00,000 -----------------Cash flow ---30,000 30,000 40,000 45,000
12. Consider two projects X and Y, being evaluated by a firm that has a cost of capital
of 10 per cent. calculate IRR and NPV for the projects:
Year
C0
C1
C2
C3
C4
Project X 1,10,000 31,000 40,000 50,000 70,000
Project Y 1,10,000 71,000 40,000 40,000 20,000
13. A company has to select one of the following two projects:
Year
0
1
2
3
4
Project X 11,000 6,000 2,000 1,000 5,000
Project Y 10,000 1,000 1,000 2,000 10,000
Calculate IRR. Suggest the best alternative on the above basis.
14. 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. From the following information, prepare a profitability
statement for submission to the management and calculate PBP.
Particulars
Machine A
Estimated life (years)
5
Cost of machine
80,000
Estimated additional cost:
Indirect material (p.a)
2,000
Maintenance (p.m)
500
Supervision (per quarter)
3,000
Estimated savings:
a. Workers not required
10
b. Wages per worker (pa) 72,00
Savings in scrap
8,000
Depreciation is calculated under straight line method.
50 per cent of net profit.

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Machine B
6
1,50,000
3,000
750
4,500
15
7,200
12,000
Taxation may be taken at

15. Ramnath washing machines ltd is considering the purchase of a new machine
which would carry out some operations performed by manual labour. A and B are
alternative models. The following information is available. Using payback period,
identify the most profitable investment.
Particulars
Machine A Machine B
Cost of machine
15,000
25,000
Estimated life of the machine
5 years
6 years
Estimated cost of indirect labour (pa)
600
800
Estimated savings in scrap
1,000
1,500
Estimated savings in direct wages:
a. Workers not required
15
20
b. Wages per worker
600
600
Additional cost of the maintenance (pa) 700
1,100
Additional cost of supervision (pa)
1,200
1,600
Assume a tax rate of 50 per cent
16. KMF wants to replace the manual operations by a new machine. There are two
alternative models, A and B of the new machine. Using payback period, suggest
the most profitable investment:
Particulars
Machine A Machine B
Cost of the machine
9,000
18,000
Estimated life of the machine
4 years
5 yeas
Estimated savings in scrap
500
800
Estimated savings in direct wages
6,000
8,000
Additional cost of the maintenance 800
1,000
Additional cost of supervision
1,200
1,800
Ignore taxation
17. Rank the following projects using NPV and PBP:
Projects
Initial investment
Annual cash flows
A
5,00,000
1,00,000
B
6,00,000
1,50,000
C
6,50,000
1,25,000
D
8,00,000
2,00,000
E
7,50,000
2,20,000

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Life in years
7 years
5 years
9 years
5 years
6 years

18. United Industries Ltd., has an investment budget of Rs. 100 lakhs for 2005-2006.
It has short listed two projects A and B after completing the market and technical
appraisal. The management wants to complete financial appraisals before making
the investments. Further particulars regarding the two projects are given below:
Particulars
A
B
Investment required
100 lakhs 90 lakhs
Average annual cash flows before Dept and Tax
28 lakhs
24 lakhs
Salvage value
----------- --------Estimated life (years)
1o years 10 years
The company follows straight line method of charging depreciation. Its tax rate is
50%. You are required to calculate payback period and internal rate of return of
the two projects.
19. What is the internal rate of return on an investment which involves a current
outlay of Rs. 3,00,000 and results in an annual cash inflows of Rs. 60,000 for 7
years?
20. If an equipment costs Rs. 5,00,000 and lasts 8 years, what should be the
minimum annual cash inflow before it is worthwhile to purchase the equipment?
Assume that the cost of capital is 10 per cent.
21. How much can be paid for a machine which brings in an annual cash inflows o Rs.
25,000 for 10 years. Assume that the discount rate is 12 per cent.
22. The expected cash flows of a project are as follows:
Years
0
1
2
3
4
5
Cash flows 1,00,000 20,000 30,000 40,000 50,000 30,000
The cost of capital is 12 per cent. Calculate the following: Net present value,
Benefit cost ratio, IRR, MIRR, PBP and ARR
23. A company is considering an investment proposal to install a new milling control
at a cost of Rs. 50,000. The facility has a life expectancy of 5 years without any
salvage value. The firm uses SLM of depreciation and the same is used for tax
purposes. The tax rate is assumed to be 35%. The estimated cash flows before
depreciation and tax from the investment proposal are as follows:
Years
1
2
3
4
5
Cash flows 10,000 10,692 12,769 13,462 20,385
before tax
Calculate: payback period, ARR, NPV at 10 per cent and PI at 10% discount rate.

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24. Sulabh International is evaluating a project whose expected cash flows are as
follows:
Year
0
1
2
3
4
5
Cash flows 10,00,000 1,00,000 2,00,000 3,00,000 6,00,000 3,00,000
a. What is the NPV of the project, if the discount rate is 14 per cent for the
entire period?
b. What is the NPV of the project if the discount rate is 12 per cent for year 1
and rises every year by 1 per cent?
25. Your company is considering two mutually exclusive projects, A and B. project A
involves an outlay of RS. 100 million which will generate an expected cash inflow
of Rs. 25 million per year for 6 years. Project B calls for an outlay of Rs. 50 million
which will produce an expected cash inflow of Rs. 13 million per years for 6 years.
The company cost of capital is 12 per cent.
Calculate the NPV and IRR of each project.
26. The expected cash flows of a project are as follows:
Year
0
1
2
3
4
5
Cash flows 1,00,000 20,000 30,000 40,000 50,000 30,000
The cost of capital is 12 per cent. Calculate NPV, BCR, IRR, MIRR, PBP and ARR.
27. Your company is considering two projects M and N, each of which requires an
initial outlay of Rs. 50 million. The expected cash inflows from these projects are:
Year
1
2
3
4
Project M 11 million 19 million 32 million 37 million
Project N 38 million 22 million 18 million 10 million
a. What is the payback period for M and N?
b. If cost of capital is 14 per cent, what is the MIRR of each project?
28. OZS Enterprises is considering a project proposal for replacement on an old machine by
new machine. The old machine bought a few years ago has a book value of Rs. 4,00,000
and it can be sold to realize a post tax salvage value of Rs. 5,00,000. It has a remaining
life of five years after which its net salvage value is expected to be Rs. 1,60,000. It is
being depreciated annually at a rate of 25 per cent under the WDV method. Working
capital for the old machine is Rs. 4,00,000. The new machine costs Rs. 16,00,000. it is
expected to fetch a net salvage value of Rs. 8,00,000 after 5 years, when it will be no
longer required. The depreciation rate applicable to it is 25 per cent under the WDV
method. The net working capital required for the machine is Rs. 5,00,000. The new
machine is expected to bring a saving of Rs. 3,00,000 annually in manufacturing costs.
Tax rate applicable to firm is 40 per cent. Given the above information advice the firm
based on incremental after tax cash flow.

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29. Teja International is determining the cash flow for a project involving replacement of an
old machine by a new machine. The old machine bought a few years ago has a book
value of Rs. 8,00,000 and it can be sold to realize a post-tax salvage value of Rs.
9,00,000. It has a remaining life of five years after which its net salvage value is expected
to be Rs. 2,00,000. It is being depreciated annually at a rate of 25 per cent under the
WDV method. The working capital associated with this machine is Rs.5,00,000.
The new machine costs Rs. 30,00,000. It is expected to fetch a new salvage value of Rs.
15,00,000 after five years. The depreciated rate applicable to it is 25 per cent under the
WDV method. The net working capital required for the new machine is Rs. 15,60,000
and is expected to bring a saving of Rs. 6,50,000 annually in manufacturing costs. The
tax rate applicable to the firm is 30 per cent.
a. Estimate the cash flow associated with the replacement project.
b. What is the NPV of the replacement project if cost of capital is 14 per cent?
30. Mahima enterprises considering replacing old machinery by a new machine. The old
machine bought few years ago has a book value of Rs. 90,000 and it can be sold for Rs.
9,000. It has a remaining life of five years after which its net salvage value is expected to
be Rs.10,000. It is being depreciated annually at the rate of 20 per cent as per the WDV
method.
The new machine costs Rs. 4,00,000. It is expected to fetch a net salvage value of Rs.
25,000 after 5 years. It will be depreciated annually at the rate of 25 per cent as per the
WDV method. Investment in working capital will not change with the new machine. The
tax rate for the firm is 35 per cent. Estimate the cash flow associated with the
replacement proposal, assuming other costs remain unchanged and savings of Rs.
1,50,000.

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