#2 Techniques of Capital Budgeting solved illustrations pdf Financial Management notes with solved illustrations capital budgeting numericals with solutions pdf capital budgeting notes with solved problems pdf

   Techniques of Capital Budgeting Part 2 solved questions with solutions

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3. Machine A costs 1,80,000 payable immediately. Machine B costs Rs. 2,00,000 half payable immediately and half payable in one year's time. The cash receipts expected are as follows:

Year at end	Machine A	Machine B
1	40,000	----------
2	60,000	80,000
3	70,000	1,00,000
4	50,000	1,20,000
5	50,000	-----------

At 8 % opportunity cost, which machine should be selected on the basis of NPV?

Solution

Year	Machine A			Machine B
	Cash Flow	PVF0.08	PV = Cash Flow × PVF0.08	Cash Flow	PVF0.08	PV= Cash Flow × PVF0.08
0	(1,80,000)	1.000	(1,80,000)	(1,00,000)	1.000	(1,00,000)
1	40,000	0.926	37,040	(1,00,000)	0.926	(92,600)
2	60,000	0.857	51,420	80,000	0.857	68,560
3	70,000	0.794	55,580	1,00,000	0.794	79,400
4	50,000	0.735	36,750	1,20,000	0.735	88,200
5	50,000	0.681	34,050	-----------	0.681	--------
	NPV		34,840	NPV		43,560

NPV = PV of Cash inflow – PV of Cash outflow

NPV of Machine B is higher than Machine A. Hence, Machine B should be selected.

4. A company is considering a new project for which requires a Capital outlay of Rs. 5,00,000 and depreciation is to be allowed at 20 % on SLM basis. Forecasted annual earnings before charging depreciation is as follows:

Year	Earnings (Rs.)
1	2,50,000
2	2,50,000
3	1,00,000
4	1,20,000
5	80,000
Total	8,00,000

Evaluate the project using (a) Payback method. (b) Rate of return on original investment.

Solution

Payback Period

Year	Rs.	Cumulative
1	2,50,000	2,50,000
2	2,50,000	5,00,000
3	1,00,000	6,00,000
4	1,20,000	7,20,000
5	80,000	8,00,000
Total	8,00,000

 

Payback period = 2 years (Money invested or Capital outlay of Rs. 2,00,000 has been recovered in 2 years.)

Rate of return on original investment

Year	Earnings (Rs.)	Less: Depreciation	Net Earnings
1	2,50,000	(1,00,000)	1,50,000
2	2,50,000	(1,00,000)	1,50,000
3	1,00,000	(1,00,000)	0
4	1,20,000	(1,00,000)	20,000
5	80,000	(1,00,000)	(20,000)
Total			3,00,000

Average income = Total net income / no. of years = Rs.3,00,000 / 5 = Rs. 60,000

Rate of return on original investment = (Average income ÷ original investment) × 100

= (Rs. 60,000 ÷ Rs.5,00,000) × 100 = 12 %.

5. RBL Academy is considering a project with an initial outflow of Rs. 1,20,000 with following cash inflow:

Year	Cash inflow
1	32,000
2	28,000
3	30,000
4	30,000
5	29,000
Total	1,49,000

Comment on the project considering cost of capital to be 7% using internal rate of return method.

Solution

Calculation of Internal rate of return

Cash outflow = Rs.1,20,000

Average cash inflow = Total cash inflow / number of years = Rs. 1,49,000 / 5 = Rs. 29,800

Approximate payback period = Cash outflow / average cash inflow

= Rs. 1,20,000 /Rs.29,800 = 4.0268

In PVAF table, value near to 4.0268 in year 5 is 4.1002 at 7 % and 3.9927 at 15%.

Year	Cash inflow	PVF at 7%	PVF at 8%	PV at 7% = Cash inflow × PVF at 7%	PV at 8% = Cash inflow × PVF at 8%
0	(1,20,000)	1	1	(1,20,000)	(1,20,000)
1	32,000	0.9346	0.9259	29907.2	29628.8
2	28,000	0.8734	0.8573	24455.2	24004.4
3	30,000	0.8163	0.7938	24489	23814
4	30,000	0.7629	0.735	22887	22050
5	29,000	0.713	0.6806	20677	19737.4
Total of PV of cash inflow				122415.4	119234.6
NPV= Total of PV of cash inflow – PV of cash outflow				2415	(765.4)

 

Using interpolation formula

IRR = Lower discount rate + [NPV at lower rate / (NPV at lower rate – NPV at higher rate) × (Difference between two rates)]

= 7% + [2415/2415-(-765.4) × (8% - 7%)]

= 7% + [(2415/3180.4) × 1 %]

7% + 0.7593% = 7.7593 %

Since cost of capital is 7% and IRR is 7.7593%. Hence project should be included.

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