ACHARYA INSTITUTE OF TECHNOLOGY

DEPARTMENT OF MBA

CAPITAL BUDGETING(INVESTMENT EVALUATION) TECHNIQUES

1.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 and no salvage value. The tax rate is 35%. Assume the firm
uses straight line depreciation and the same is allowed for tax purposes. The estimated cash flows
before depreciation and tax (CFBT) from the investment proposal are as follows:

Year 1 2 3 4 5

CFBT(Rs) 10,000 10,692 12,769 13,462 20,385

Compute the following:

(I)Pay back period (ii)Average rate of return (iii)NPV at 10% discount rate and(iv)Profitability Index at
10% discount rate (January 2015/12MBA25)(June 2013/10MBA23)(June 2010/05MBA23)

2.ITC Ltd has decided to purchase a machine to augment the company’s installed capacity to meet the
growing demand for its products. There are three machines under consideration of the management. The
relevant details including estimated yearly expenditure and sales are given below. All sales are on cash.
Corporate income-tax rate is 40%. Interest on capital may be assumed to be 10%.

Particulars Machine Machine2(Rs) Machine

1(Rs) 3(Rs)
Initial investment 3,00,000 3,00,000 3,00,000
Estimated annual sales 5,00,000 4,00,000 4,50,000
Cost of production:
Direct material 40,000 50,000 48,000
Direct labour 50,000 30,000 36,000
Factory overhead 60,000 50,000 58,000
Administration cost 20,000 10,000 15,000
Selling&Dist. cost 10,000 10,000 10,000

The economic life of machine 1 is 2 years while it is 3 years for the other two. The scrap values are
Rs.40,000, Rs.25,000 and Rs.30,000 respectively. You are required to find out the most profitable
investment based on payback period method. (June 2013/10MBA23)

3.Arun Ltd has Rs.2,00,000 to invest. The following proposals are under consideration. The cost of
capital for the company is estimated to be 15%

project Initial outlay(Rs) Annual cash flow (Rs) Life of project

A 1,00,000 25,000 10
B 70,000 20,000 8
C 30,000 6,000 20
 D 50,000 15,000 10
E 50,000 12,000 20

Rank the above projects on the basis of: i) NPV method and ii) Profitability Index method

(Jan 2015/12MBA25)

4.The expected cash flows of a project are as follows:

year 0 1 2 3 4 5
Cash flow 1,00,000 20,000 30,000 40,000 50,000 30,000
The cost of capital is 12%. Calculate the following;

i) NPV ii)Benefit Cost Ratio iii) IRR iv)MIRR and v) Payback Period (June 2012/10MBA23)

5. 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 appraisals. The management wants to
complete financial appraisals before making the investments. Further particulars regarding two projects
are given below:

Particulars A B
Investment required(Rs-Lakhs) 100 90
Average annual cash inflows before depreciation and tax 28 24
(estimate) (Rs-Lakhs)
Salvage value - -
Estimated life (Yrs) 10 10
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. PV of annuity of Re.1
for ten years at different discount rates is given below:

Rate% 10 11 12 13 14 15
Annuity value 6.1446 5.8992 5.6502 5.4262 5.2161 5.0188
for 10 years
(Dec 2012/10MBA23)

6..Ojus enterprises is determining the cash flows 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.4,00,000 and it can be
sold to realize a post tax salvage value of Rs.5,00,000. It has remaining life of 5 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% under the
written down value method. The working capital required 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 no longer be required. The depreciation rate applicable to it is 25% under written down value
method. The net working capital required for the new machine is Rs.5,00,000. The new machine is
expected to bring a saving of Rs.3,00,000 annually in manufacturing costs(other than depreciation). The
tax rate applicable to the firm is 40%. Find the incremental after tax cash flows associated with the
replacement project. (Dec 2012/10MBA23)
7.A company is considering the replacement of its existing machine which is obsolete and unable to meet
the rapidly rising demand for its product. The company is faced with two alternatives:

i) to buy machine A which is similar to the existing machine which costs Rs25 lakhs

ii) to go in for machine B which is more expensive and has much greater capacity which costs Rs.40
lakhs

The cash inflows from these machines are as follows:

year Machine A(in lakhs) Machine B(in lakhs)

1 - 10
2 5 14
3 20 16
4 14 17
5 14 15
The company’s cost of capital is 10%. The finance manager tries to evaluate the machine by calculating
the following:

i) NPV ii)Profitability Index and iii)Payback period

At the end of his calculations, however the finance manager is unable to make up his mind as to which
machine to recommend. You are required to make these calculations and in the light there of to advise
finance manager about the proposed investment. (July 2011/10MBA23)

8. A company has to make a choice between two projects namely project A and project B. The initial
capital outlay of two projects are Rs.1,35,000 and Rs.2,40,000 respectively for A and B. The opportunity
cost of capital is 16%. The annual incomes are as under:

year Project A Project B Discounting

factor@16%
1 - 60,000 0.862
2 30,000 84,000 0.743
3 1,20,000 96,000 0.641
4 84,000 1,02,000 0.552
5 84,000 90,000 0.476
You are required to calculate for each project.

i) Discounted pay back period ii) Profitability index iii) Net present value (Dec 2010/08MBA23)

9.Excellent Ltd has to choose one of the following two mutually exclusive projects. Both the projects
have to be depreciated on straight line basis. The tax rate is 50%. The initial investment is Rs.30,000
each.

year Project X(Rs) Project Y(Rs)

1 8,400 8,400
 2 9,600 9,000
3 14,000 8,000
4 16,000 10,000
5 4,000 20,000
Use the pay back period as the criterion for project selection. (Dec 2010/08MBA23)

10.A company is considering an investment proposal to install a new machine. The project will cost
Rs.50,000 and will have a life of 5 years and no salvage value. Tax rate is 50%, the company follows
straight-line method of depreciation. The net earnings before depreciation and tax is as follows:

Year 1 2 3 4 5
EBDT(Rs) 10,000 11,000 14,000 15,000 25,000
Evaluate the project using: i)PBP ii)ARR iii)NPV at 10% and iv) PI at 10% discount factor.

(July 2014/12MBA25)

11.Naveen enterprises is considering a capital project about which the following information is available:

i)The investment outlay on the project will be Rs.100 million. This consists of Rs.80 million on plant
and machinery and Rs.20 million on net working capital. The entire outlay will be incurred at the
beginning of the project.

ii)The project will be financed with Rs.45 million of equity capital, Rs.5 million of preference capital, and
Rs.50 million of debt capital. Preference capital will carry a dividend rate of 15%, debt capital will carry
an interest rate of 15%.

iii)The life of the project is expected to be 5 years. At the end of 5 years, fixed assets will fetch a net
salvage value of Rs.30 million whereas net working capital will be liquidated at its book value.

iv)The project is expected to increase revenues of the firm by Rs.120 million per year. The increase in
costs on account of the project is expected to be Rs.80 million per year(this includes all items of cost
other than depreciation, interest and tax). The effective tax rate will be 30%.

v)Plant and machinery will be depreciated at the rat of 25% per year as per the written down value
method. Hence, the depreciation charges will be:

First year=Rs.20 million, Second year=Rs.15 million, Third year=Rs.11.25 million, Fourth
year=Rs.8.44 million, Fifth year=Rs.6.33 million.

From the above information, estimate the project’s cash flows. (July 2014/12MBA25)

12.The expected cash flows of a project are as follows:

year 0 1 2 3 4 5
Cash flow -1,00,000 20,000 30,000 40,000 50,000 30,000
The cost of capital is 12%. Calculate the following: i)NPV ii)Benefit cost ratio iii)IRR iv)PBP and v) Pay
Back Period. (June 2013/08MBA23)
13.Paramount Ltd is evaluating a project that has the following cash flow stream associated with it.

year Cash outflows(in Cash inflows(in million)

million)
0 120 -
1 80 -
2 - 20
3 - 60
4 - 80
5 - 100
6 - 120
Calculate modified internal rate of return. The cost of capital for Paramount Ltd is 15%

(Dec2010/05MBA23)

14. Aasmann Ltd has currently under examination a project will yield the following returns over the life
of the project ( June 2009/08MBA23)

year 1 2 3 4 5
Gross yield(Rs) 80,000 80,00 90,000 90,000 83,000
0

Cost of machinery to be Rs.2, 00,000 and the machine is to be depreciated at 20% p.a at written down
value basis. Income tax rate is 50%. The salvage value of machine is zero. If the average cost of raising
capital is 11% would you recommend accepting the project under the internal rate of return method?

15. Compute MIRR of the following project (Jan 2016/14MBA22)

Year 0 1 2 3 4 5 6
Cash 4,85,000 85,400 96,500 1,32,600 2,16,000 1,24,000 98,500
flow(Rs)
Cost of capital 12%.