5th Semester : Financial Management Capital Budgeting

Session: 048

Problems on Internal Rate of Return

Advanced problems covering more than one method

1. A firm can make investment in either of the following two projects. The firm
anticipating its cost of capital to be 10 % and the net (after tax) cash inflows
of the projects for 5 years are as follows:

Year 0 1 2 3 4 5
Project X (500000) 85000 200000 240000 220000 70000
Project Y (500000) 480000 100000 70000 30000 20000

The discount factors are as follows

Year 0 1 2 3 4 5
PVF @10% 1 .91 .83 .75 .68 .62
PVF @20% 1 .83 .69 .58 .48 .41

Required:
I. Calculate the NPV and IRR of each projects
II. State with reason which project would you recommend.

Source: Financial Management/ SHAHI K GUPTA AND R.K SHARMA

Solution:
Given,
• The cash flows are given (assumed to be after tax and before
depreciation)
• Present value factors at 10 % and 20 % rate are also given.

Digital Learning – DCE Kuvempu University, Shivamogga Page 1

 5th Semester : Financial Management Capital Budgeting

A. Calculation of NPV and IRR of project X

year Discount Project X Discount Project X
factor @ Cash inflows Present value factor @ 20 Cash Present value
10 % of % inflows of
cash inflows cash inflows
01 .91 85000 77350 .83 85000 70550
02 .83 200000 166000 .69 200000 138000
03 .75 240000 180000 .58 240000 139200
04 .68 220000 149600 .48 220000 105600
05 .62 70000 43400 .41 70000 28700
Total of present value of cash 616350 482050
inflows
Initial outlay 500000 500000
Net Present Value 116350 (17950)

❖ The NPV of project X at 10% rate is ₹ 116350

❖ IRR of the project X is,

116350
𝐼𝑅𝑅 = 10 + × 10
116350 + 17950

𝐼𝑅𝑅 = 10 + 0.866 × 10

= 10 + 8.66

𝑰𝑹𝑹 = 𝟏𝟖. 𝟔𝟔 %

B. Calculation of NPV and IRR of project X

year Cash Discount Present value Discount Present Discount Present value of
inflows factor @ of factor @ value of factor @ cash inflows
10 % cash inflows 20 % cash inflows 30%
01 480000 .91 436800 .83 398400 .77 369600
02 100000 .83 83000 .69 69000 .59 59000
03 70000 .75 52500 .58 40600 .45 31500
04 30000 .68 20400 .48 14400 .35 10500
05 20000 .62 12400 .41 8200 .27 5400
Total of present value of 605100 530600 476000
cash inflows
Initial outlay 500000 500000 500000
Net Present Value 105100 30600 (24000)

Digital Learning – DCE Kuvempu University, Shivamogga Page 2

5th Semester : Financial Management Capital Budgeting

❖ The NPV of project X at 10% rate is ₹ 105100

❖ IRR of the project X is,

30600
𝐼𝑅𝑅 = 20 + × 10
30600 + 24000

𝐼𝑅𝑅 = 20 + 0.56 × 10

= 20 + 5.60

𝑰𝑹𝑹 = 𝟐𝟓. 𝟔𝟎 %

Recommendation:
Method/ Technique Project X Project Y Remarks
NPV method @ 10% ₹ 116350 ₹ 105100 Project ‘X’ is preferable as the
NPV is higher than that of
project ‘Y’.

IRR method 𝟏𝟖. 𝟔𝟔 % 𝟐𝟓. 𝟔𝟎 % Project ‘Y’ is preferable as the

IRR of project Y is more than
that of project ‘X’

2. A choice is to be made between two competing proposals which require an

equal investment of ₹ 50000 and are expected to generate net cash inflows
as under.

Project A Project B
Investment ₹ 50000 ₹ 50000
Year Cash inflows in ₹ Cash inflows ₹
1 25000 10000
2 15000 12000
3 10000 18000
4 Nil 25000
5 12000 8000
6 6000 4000

Digital Learning – DCE Kuvempu University, Shivamogga Page 3

5th Semester : Financial Management Capital Budgeting

The cost of capital of the company is 10 %. The following are the present value
factors at 10 % per annum.

Present value tables

Years 1 2 3 4 5 6
Present value @ 10 % .909 .826 .751 .683 .621 .564

Which project proposal should be selected and why?

Evaluate the projects using
a. Pay-back period
b. Net present value method
Source: Financial Management/ B. S Raman

Solution:

Given,
• The cash flows are given (assumed to be after tax and before
depreciation)
• Present value factors at 10 % rate are also given.

A. Evaluation of projects using PBP

• Original investment of projects ₹ 50000 each.
• cash inflows are uneven, therefore we need to calculate cumulative cash flows

Calculation of cumulative cash inflows

year Project A Project B
Cash inflows Cumulative cash inflows Cash inflows Cumulative cash inflows
01 25000 25000 10000 10000
02 15000 40000 12000 22000
03 10000 50000 18000 40000
04 Nil 50000 25000 65000
05 12000 62000 8000 73000
06 6000 68000 4000 77000

Digital Learning – DCE Kuvempu University, Shivamogga Page 4

 5th Semester : Financial Management Capital Budgeting

❖ PBP for project A is 3 years

❖ Project B’s investment is not completely recovered in the 3rd year and part
of investment to be recovered in the 4th year, therefore the pay back
period for project B can be calculated as below.

unrecovered cost at the

beginning of the year
PBP = years before full recovery + ( ) × 12 months
cash flows during the year

10000
PBP = 3 Years + ( ) × 12 months
25000
= 3 years + (0.4 x 12 months)
PBP of Project B = 3.4 years OR 3 years and 4.8 months.

B. Evaluation of projects using NPV

Statement showing present values of cash inflows
year Discount Project A Project B
factor @ Cash inflows Present value of Cash inflows Present value of
10 % cash inflows cash inflows
01 .909 25000 22725 10000 9090
02 .826 15000 12390 12000 9912
03 .751 10000 7510 18000 13518
04 .683 Nil Nil 25000 17075
05 .621 12000 7452 8000 4968
06 .564 6000 3384 4000 2256
Total of present value of cash inflows 53461 56819
Initial outlay 50000 50000
Net Present Value 3461 6819

Digital Learning – DCE Kuvempu University, Shivamogga Page 5

5th Semester : Financial Management Capital Budgeting

Recommendation:
Method/ Technique Project A Project B Remarks
Payback period 3 years 3.4 years Project ‘A’ is preferable
as the PBP is lower.
Net Present Value ₹ 3461 ₹ 6819 Project ‘B’ is preferable
Method as the NPV of project B
is more than that of
project ‘A’

Digital Learning – DCE Kuvempu University, Shivamogga Page 6

5th Semester : Financial Management Capital Budgeting

Reference
• Dr. S.N. Maheshwari, Elements Of Financial Management,

• Prasanna Chandra, Financial Management

• V Rajeshkumar and Y Nagaraju, Financial Management

• Lakshmeesha and Akshatha M, Financial Management

• Shahsi k Gupta and R K Sharma, Financial Management Kalyani Publishers

• B S Raman, Financial Management , united publishers

• www.icmai.in

• www.icai.org

Digital Learning – DCE Kuvempu University, Shivamogga Page 7

5th Semester : Financial Management Capital Budgeting

ANNEXURE -1

Present value of an annuity of ₹ 1

Years Interest rates (r)

(n)
1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Years Interest rates (r)

(n)
11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065
16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

Digital Learning – DCE Kuvempu University, Shivamogga Page 8

 5th Semester : Financial Management Capital Budgeting

Years Interest rates (r)

(n)
(cumulative present values of the annuity of ₹ 1)

1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606
16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824
17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201
19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365
20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Years Interest rates (r)

(n)
11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675
16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730
17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775
18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812
19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843
20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870

Digital Learning – DCE Kuvempu University, Shivamogga Page 9