Capital Budgeting

1. Discounted Cash Flow Method

2. Non discounted Cash Flow Method

Ex1
Initial Investment=500000, A=15%, B=30%
Year Cash Flow
1 (25000)+180000+(40000)=115000
2 (25000)+250000+(25000)=200000
3 (25000)+300000+(10000)=265000
4 (25000)+250000=225000
5 (25000)+150000=125000
Year Cash Flow 15% PV 30% PV
0 500000
1 115000 0.870 100050 0.769 88435
2 200000 0.756 151200 0.592 118400
3 265000 0.658 174370 0.455 120575
4 225000 0.572 128700 0.350 78750
5 125000 0.497 62125 0.269 33625
TPV 616445 439785

A=15%,NA (NPV for 15%)= TPV-Initial Investment

=616445-500000=116445
B=30%, NB (NPV for 30%) = TPV – Initial Investment
=439785-500000=(60215)
NA
IRR=A + NA−NB (B-A)
116445
=15+116445+60215 (30-15)
=15+9.8872=24.9%=25%
IRR is higher than the cost of capital of 20%, so project is acceptable.
(or) IRR>20%, so project is acceptable.

Ex2
For project one
Year Cash Flow 15% PV 30% PV
0 510000
1 300000 0.870 261000 0.769 230700
2 200000 0.756 151200 0.592 118400
3 250000 0.658 164500 0.455 113750
TPV 576700 462850
A=15%, NA = TPV- Initial Investment= 576700-510000=66700
B=30%, NB= TPV- Initial Investment=462850-510000=(47150)
NA
IRR=A + NA−NB (B-A)
66700
=15+66700+47150 (30-15)
=15+8.78=23.78%=24%
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For Project Two
Year Cash Flow 15% PV 30% PV
0 650000
1 200000 0.870 174000 0.769 153800
2 300000 0.756 226800 0.592 177600
3 400000 0.658 263200 0.455 182000
TPV 664000 513400
A=15%, NA = TPV- Initial Investment= 664000-650000=14000
B=30%, NB= TPV- Initial Investment=513400-650000= (136600)
NA
IRR=A + NA−NB (B-A)
14000
=15+14000+136600 (30-15)
=15+1.39=16.39%=16%
IRR1 > IRR2 (Project 1 should be invest)
KOCHA should investment in Project one.

Ex3
Initial Investment=350000
Year Cash Flow
1 (15000)+180000+(40000)=125000
2 (15000)+250000+(30000)=205000
3 (15000)+200000=185000

Year Cash Flow 10% PV 20% PV

0 350000
1 125000 0.909 113625 0.833 104125
2 205000 0.826 169330 0.694 142270
3 185000 0.751 138935 0.578 106930
TPV 421890 353325
A=10%, NA = TPV- Initial Investment= 421890-350000=71890
B=20%, NB= TPV- Initial Investment=353325-350000=3325
NA
IRR=A + NA−NB (B-A)
71890
=10+71890−3325 (20-10)
=10+10.48=20.48%=21%
IRR is higher than the cost of capital 10%, so project is acceptable.
(or) IRR>10%, so project is acceptable.

Ex4
(a) For Investment I
Initial investment=405000
Life=7 years, r=15%=0.15
A=108000 per annum (Annual Cash Flow)
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛

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 1 1
TPV= 108000 * 0.15 ⌊1 − ⌋
(1.15)7
TPV=108000* 4.160= 449280
NPV=TPV-Initial Investment=449280-405000=44280

For Investment II
Initial Investment=510000
Life= 4 years, r=15%=0.15
A=210000 per annum (Annual Cash Flow)
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛
1 1
TPV= 210000 * 0.15 ⌊1 − ⌋
(1.15)4
TPV=210000*2.855=599550
NPV=TPV-Initial Investment=599550-510000=89550

For Investment III

Initial Investment=630000
Life=8 years, r=15%=0.15
A=171000 per annum (Annual Cash Flow)
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛
1 1
TPV= 171000 * 0.15 ⌊1 − ⌋
(1.15)8
TPV=171000*4.487=767277
NPV=TPV-Initial Investment=767277-630000=137277

For Investment IV
Initial Investment=270000
r=15%=0.15
Year Cash Flow 15% PV
0 270000
1 0
2 135000 0.756 102060
3 135000 0.658 88830
TPV 190890
NPV=TPV-Initial Investment=190890-270000=(79110)

(b) I would reject investment IV because NPV is less than zero.

(c)For Investment III

A=15%, NA =137277
B=30%,NB=?
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛
1 1
TPV= 171000 * 0.3 ⌊1 − (1.3)8
⌋
TPV=171000*0.233=39843
NPV=TPV-Initial Investment=39843 -630000= (590157)
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 NA
IRR=A + NA−NB (B-A)
137277
=15+137277+590157 (30-15)
=15+7.7=22.7=23

Initial Investment
(d)Payback period =𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤
405000
Payback period = 108000 =3.75=3 years 9 month
Ex5

(a) Weighted Average cost of capital=proportion of total capital* cost of financing

300000 500000
=800000 *0.2 + 800000 *0.15

=0.075+0.09375=0.16875

For percentage(%)=0.16875*100=16.8=17%

(b)
Year Cash In Flow Cash Out flow Cash Flow
0 800000
1 1000*400=400000 1000*(70+60+20)=150000 250000
2 1000*400=400000 1000*(70+60+20)=150000 250000
3 1000*400=400000 1000*(70+60+20)=150000 250000
4 1000*400=400000 1000*(70+60+20)=150000 250000
5 1000*400=400000 1000*(70+60+20)=150000 250000
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛

1 1
TPV= 250000 * 0.17 ⌊1 − ⌋=250000*3.199=799750
(1.17)5
NPV=TPV-Initial Investment=799750-800000=(250)

(c)IRR=?
A=15% , NA=?
B=17%, NB=(250)
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛

1 1
TPV= 250000 * 0.15 ⌊1 − ⌋=250000*3.352=838000
(1.15)5
NPV=TPV-Initial Investment=838000-800000=38000
NA
IRR=A + NA−NB (B-A)
38000
=15+38000+250 (17-15)
=15+1.99=16.99=17%

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Ex6
(a) Weighted Average cost of capital=proportion of total capital* cost of financing
300000 200000
=500000 *0.2 + 500000 *0.12

=0.12+0.048=0.168

For percentage(%)=0.168*100=16.8=17%

(b) Project A
1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛

1 1
TPV= 200000 * 0.17 ⌊1 − ⌋=200000*3.199=639800
(1.17)4
NPV=TPV-Initial Investment=639800-500000=139800

Project B
Year Cash Flow 17% PV
0 500000
1 200000 0.855 171000
2 300000 0.731 219300
3 200000 0.624 124800
4 400000 0.534 213600
TPV 728700
NPV=TPV-Initial Investment=728700-500000=228700

(c) For Project A

𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 500000
Payback period= 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑎𝑠ℎ 𝐼𝑛 𝐹𝑙𝑜𝑤 = 200000 = 2.5= 2 years 6 month

For Project B
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑏𝑎𝑙𝑎𝑛𝑐𝑒
Payback period= Years+ 𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑖𝑛 𝑓𝑙𝑜𝑤 𝑖𝑛 𝑛𝑒𝑥𝑡 𝑦𝑒𝑎𝑟 * 12 months
0
=2+ *12 = 2 years
200000

Ex7
Year Cash In Cash Out Cash Flow
1 40000*3=120000 40000*1.25=50000 70000
2 40000*3=120000 40000*1.25=50000 70000
3 30000*3=90000 30000*1.25=37500 52500
4 20000*3=60000 20000*1.25=25000 35000
5 20000*3=60000 20000*1.25=25000 35000

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 𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑏𝑎𝑙𝑎𝑛𝑐𝑒
(i) Payback period= = Years+ 𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑖𝑛 𝑓𝑙𝑜𝑤 𝑖𝑛 𝑛𝑒𝑥𝑡 𝑦𝑒𝑎𝑟 * 12 months
10000
=2+ 52500 *12 = 2+2.8= 2 years 3 month

(ii)
Year Cash Flow 20% PV
0 150000
1 70000 0.833 58310
2 70000 0.694 48580
3 52500 0.579 30397
4 35000 0.482 16870
5 35000 0.402 14070
168227
NPV= TPV- Initial Investment
NPV=168227-150000=18227

Ex8
(a) Hire
A= £ 4835 per annum
n=5 years,
r=10%

1 1
TPV= A * 𝑟 ⌊1 − ⌋
(1+𝑟)𝑛

1 1
TPV= 4835 * 0.1 ⌊1 − ⌋=4835*3.791=18329
(1.1)5
NPV=TPV- Initial Investment= 18329-0=18329

(b)Hire Purchase

Year Cash Flow 10% PV

0 8000
1 3000 0.909 2727
2 3000 0.826 2478

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 3 0 0.751 0
4 0 0.683 0
5 3000 0.621 1863
TPV 7068

NPV=TPV- Initial Investment= 7068-8000=(932)

(c) Purchasing
Year Cash Flow 10% PV
0 20000
1 0
2 0
3 0
4 0
5 3000 0.621 1863

NPV=TPV- Initial Investment= 1863-20000=18137

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