CAPITAL BUDGETING

CLASS ASSIGNMENT

Q1: The following two projects A and B require an investment of Rs.2,00,000 each. The net cash
flows for these projects are as follows:

Years Project A Project B

1 80,000 20,000
2 80,000 40,000
3 40,000 40,000
4 20,000 40,000
5 - 60,000
6 - 60,000

Using the following criteria, determine which project is favourable:

a) 8 years pay back

b) Present Value approach, if company’s cost of capital is 10%

Q2: ABC ltd. Has to make a choice between two machines X and Y. The two machines are designed
differently, but have identical capacity and do exactly same job. Machine X costs Rs. 1,50,000 and will
last for 3 years. It costs Rs. 40,000 per year to run. Machine Y is economy model costing only Rs.1,00,000
but will last only for 2 years and costs Rs. 60,000 per year to run. The cash flows of machine X and Y are
real cash flows. The opportunity cost of capital is 9%. Which machine should ABC Ltd. Buy?

(The PV of annuity for 2 years and 3 years at 9% are 1.7591 and 2.5313 respectively)

Q3: A firm whose cost of capital is considering two mutually exclusive projects X and Y, the details of
which are:

Years Project X Project Y

Investment 70,000 70,000
Cash flow in year 1 10,000 50,000
Cash flow in year 2 20,000 40,000
Cash flow in year 3 30,000 20,000
Cash flow in year 4 45,000 10,000
Cash flow in year 5 60,000 10,000
Compute NPV at 10%, Profitability Index and IRR for the two projects.