FI

NANCI ALMANAGEMENT D.K.BI

SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Ti
mev
alue

Whati
sti
mev
alueofmoney
?
I
tist hemosti
mport
antmatterinfi
nanci
almanagement.Wherefi
nanci
aldeci
sionsar
econcer
ned
ti
mev al
ueofmoneyisobviousl
ytakenint
oconsider
ationfai
rl
yorduly.Moneyhast i
mev al
ue
becauseoft
hefol
l
owingr
easons:

a) I
ndi
vidualsgener
all
ypr
efercur
rentconsumpt
ion.I
tiswel
lknownt
heor
yofKey
nes— Li
qui
dit
y
Pr
eferenceTheor
y.

b) Aninvest
orcanprof
it
abl
einv
estar
upeet
odayandwant
shi
gherv
alueofr
etur
ntomor
roworaf
ter
acert
ainper
iod.

c) I
naninf
lat
ionarysi
tuat
iont
hemoneyr
ecei
vedt
odayhasmor
epur
chasi
ngpowert
hanmoneyt
o
ber
ecei
vedinfutur
e.

I
tist
hemostf
undament
alpr
inci
pleneededt
ounder
standandmakef
inanci
aldeci
sion.

2)Val
uat
ionConcept
s:

Therear
etwodi
ffer
entconcept
sint
imev
alueofmoney
—a)Compoundedv
alueofmoney
,b)pr
esent
val
ueofmoney.

Compoundedorfutureval
ueofmoneyconcept:Itmeansani
nvest
orwantstoknow,“How Much
AmountWillBe Receiv
ed Af
terCer
tai
n Per
iod ofTime”atcompound i
nter
estrat
eofpr esent
i
nvest
ment?

n
Fut
urev
alue=PV (
1+r
)

Where,PV =pr
esentval
ueofmoney
,r=compoundr
ateofi
nter
est
,
n
(
1+r)=f ut
ureval
uefactor

Presentval
ueordiscount
ingconcept:Itmeansani nv
estorwantstoknow aboutpr
esentv
alueof
fut
urecashfl
ow.I
tisthemostimportantconceptt
otakeinvest
mentdeci
sion.

1
Pr
esentv
alue=F x n
v
(
1+r
)
1
Wher
e,Fv=f
utur
ecashf
low, n =pr
esentv
aluef
act
or.
(
1+r
)

Chapt
er-
|Capi
tal
Budget
ing 1
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

PRACTI
CALPROBLEMS

Pr
ob.
1
Calcul
atecompoundi
nterestandf
utureval
ueofanamountof`1,00,
000bor
rowedatacompound
i
nterestr
ateof12%p.
a.for(i
)6months,(
ii
)1year
,(i
i
i)2y
ear
,(i
v)1095day
s,(
v)90day
s

Ans.

Pr
ob.
2
Afi
xeddepositrecei
pthasamat ur
it
yvalueof`1,30,
000.Whati
stheamountatwhi
chfixeddeposi
t
r
eceipthasbeenini
ti
all
ypur
chasedifsi
mpleint
erestrat
eis10%peryearandt
hematur
it
yperiodis3
y
ears?

Ans.

Pr
ob.
3
UshaLt
doff
ers6%rateofi
nterestondeposi
ts.Whatist
heef
fect
iver
ateofi
nter
esti
fitcompoundi
ng
i
sdone(i
)monthl
y,(
ii
)quar
terl
y,and(i
ii
)half
-year
ly.

Ans.

Pr
ob.
4
Mr.Aisoffer
edei
thertor ecei
ve`40,
000twoy ear
sfr
om now or`60,
000sev
eny
ear
sfr
om now.
WhichoneMr.Awi
llacceptandwhyifdi
scountr
atei
s11%?

Whatopt
ionshoul
dhechoosei
fthedi
scountr
atei
s6%?

Ans.

Pr
ob.
5
Aninv
est
ormakessuccessi
vei
nvest
mentf
or5y
ear
satanannuali
nter
estr
ateof5%.Hi
ssuccessi
ve
i
nvest
menti
sshownbelow:

Endofyear 1 2 3 4 5
Amountinv
est
ed 15,
000 20,
000 30,
000 35,
000 40,
000

Cal
cul
atet
heamountt
hathewi
l
lrecei
veaf
ter5y
ear
s.

Ans.

Pr
ob.
6
Mr .Dasexpect
storecei
ve`5,000attheendofyear1,`10,000att
heendofyear2,`10,
000att
he
endofy ear3,`3,
000attheendofy ear4and`2, 000attheendofyear5.Hewantstoknow t
he
presentval
ueofhi
scashflows,gi
vent
hathisr
equi
redrat
eofr et
urni
s10%.

Ans.

Chapt
er-
|Capi
tal
Budget
ing 2
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Capi
talBudget
ing

Whati
sCapi
talBudget
ingorI
nvest
mentDeci
sion?

Int
roducti
on – Invest
mentdeci
sion ofa f
ir
m means t
he capi
talbudget
ing deci
si
on orcapi
tal
expendi
turedeci
sion.

I
mpor
tance:

 I
nfluencethefi
rm’sgrowth
 Minimizet
heriskofthefir
m, i
ftheproperi
nvest
mentdeci
sioni
smade.
 I
ncreasetheretur
noft hepropr
iet
or.

St
agesofI
nvest
mentDeci
sion:

St
age Nameofthestages Content
softhestages
1 I
dent
if
icat
ionst
age Deter
minewhi chtypesofcapi
talinv
estmentsarenecessar
yto
accompli
shorgani
zati
onobj
ect
iveandstr
ategi
es.
2 Sear
chst
age Explor
e al t
ernati
ve capi tal investment
s t hat wi l
l achieve
organi
zati
on’
sobj ecti
ves.
3 I
nfor
mat
ionst
age Considertheex pected costsand benefit
sofal ter
nativ
ecapi t
al
i
nv est
ments.
4 Sel
ect
ionst
age Choose project
sf orimplement ati
on whose expected benefi
ts
exceedexpectedcostsbyt hegreatestamount
s.
5 Fi
nanci
alst
age Obtai
nf inancefrom di
ff
erentsourcesi
ncludeint
ernal
l
ygener
ated
fundalso.
6 I
mplementat
ion and Getprojectsunderwayandmoni t
orthei
rperfor
mance.
Cont
rol
stage

Ty
pesofI
nvest
mentdeci
sions:

a) Expansi
onofexist
ingbusiness:Toi
ncreaset
hepresentcapaci
tyforexi
sti
ngpr
oductt
omeet
i
ncreaseddemand,hencei
ncreasemar
ketshar
eofexist
ingpr
oducts.

b) St
art
ingofanewbusi
ness.

c) ReplacementandModer ni
zati
onofanasset:Torepl
aceanex i
sti
ngassetwithanew and
i
mpr oved one and t
oi nst
allnew machi
ner
yinthe pl
ace ofan ol
d one t
his has become
technologi
cal
l
ybackdated.

d) Di
ver
sif
icat
iondeci
sion:
Todi
ver
sif
yandent
eri
ntonewpr
oductl
i
nest
oreducet
hebusi
nessr
isk.

I
NVESTMENTCRI
TERI
A
I
nvest
mentcr
it
eri
a

Di
scount
ingt
echni
que Non-
discount
ingt
echni
que

Chapt
er-
|Capi
tal
Budget
ing 3
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Netpr
esent Benef
it
-cost i
nter
nal
rateof paybackperi
od Account
ingr
ateof
Val
ue(NPV) rat
io(
PI) r
etur
ns(I
RR) ret
urn

Techni
ques Meaning Formul
a Deci
sionr ule
NPV Sum of t he present NPV=∑pvofcashi
nfl
ow − Cr
it
eri
a Deci sion
values of cash fl
ow ∑pvofcashout
fl
ow. NPV>0 Accept t
he
Lesst hesum oft he proj ect
presentval
uesofcash NPV=0 Accept ed or
outfl
ow. reject ed
NPV<0 Rej ect t
he
proj ect

Benefitcost I
t i s one of t he PI=Pr esentval
ueofcash Cr i
ter
ia Deci sion
rati
o or discounted cash f
low i
nflow/ Present v
alue of PI>1 Accept t
he
profi
tabi
l
ity t echniques. cashoutfl
ow. project
i
ndex PI=1 Accept ed or
rej
ect ed
PI<1 Reject t
he
project

I
RR I
tist
herat
eatwhi
ch I
RR=l owerdiscountrate+ Cr i
ter
ia Deci si
on
NPV=0 (
NPVatl owerrat
e)/(NPVat IRR≥K Accept t
he
l
owerr at
e–NPVathi gher project
r
ate)
*(dif
fer
enceinrate) I
RR<K Reject t
he
project

Pay Back Itreferstotheper i

od PayBackPer iod: Cri
teri
a Decisi
on
Per
iod within whi ch t otal Pay Back Accept the
cash out f
low of the 1) whenequalcashinf
low: Peri
od ≤ pr
oject
projectisexpect
edt o Max i
mum
ber ecover
ed. = Ini
ti
al cash Acceptable
outf
low/
Annual cashi
nf l
ow payback
peri
od
2)when unequal cash Pay Back Reject t
he
i
nflow: Peri
od > project
Max i
mum
= Year up t o whi ch Accept able
cumul ativeCFAT( A)<Tot al payback
cashout fl
ow +( Totalcash per i
od
outflow–A)/CFATi nnex t
fol
lowi ngthey ear
ARR Itmeanstheav
erage ARR=( averageannualPAT Cr i
teri
a Decisi
on
annual
ret
urn /Av er ageI nvestment) *100 ARR ≥ Accept the
Wher e, Minimum pr
oject
Aver ageannual PAT acceptabl
e
rat
e of
=PAT ( beforei ntereston r et
urn
l
ong t erm debt )/t otal ARR Reject t
he
periodoft hepr oject. <Minimum project
acceptabl
e
rat
e of
ret
urn

CapitalRationing:Whent hefi
rm hasinsuf
fi
cientf
undt henthefi
rm cannotmakeinvestmentsinall
profi
tableprojects.Hencefi
rm hastochoosemor eprofi
tabl
eproj
ectswi t
hini
tsav
ail
abil
ityoffunds.
Thissituat
ioni scall
edcapit
alr
ationi
ng.Sel
ect
ionprocessundercapi
talrati
oni
ngsi
tuati
on:Iti
nvolves
thefoll
owingt wost eps:

Chapt
er-
|Capi
tal
Budget
ing 4
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

St
ep-
1 Rankingproj
ect
sont hebasi
sofpr of
it
abi
li
tymeasur
edbyt
hemostsui t
ablemethod(PI
orNPVorNPVI )
St
ep-
2 Selecti
ng t
he proj
ect
sint he descendi
ng or
derofprof
it
abi
l
ity unt
ilthe f
unds are
exhausted.

Repl
acementDecisi
on:i
tmeansdeci
sionwhet
hert
oret
aint
heexist
ingmachi
neorr
epl
acewi
tht
he
newone.Repl
acementdeci
sioni
smadefewert
hant
wosit
uat
ions:

a) Whenr
emai
ningl
if
eofexi
sti
ngmachi
neandusef
ull
if
eofnewmachi
near
esame:

I
fincr
ement
albenef
it>I
ncr
ement
alcashout
fl
ow Replacetheexi
sti
ngmachi
newi
thnewone.
I
fincr
ement
albenef
it<I
ncr
ement
alcashout
fl
ow Retaint
heex i
sti
ngmachi
ne

b) Whenr
emai
ningl
if
eofexi
sti
ngmachi
neandusef
ull
if
eofnewmachi
near
enotsame:
St
ep-
1 Cal
culateequatedannualbenef
itorequat
edannual
costofbot
hmachi
ne.
EAB=NPV/PVAForEAC=PVOfOut f
low/PVAF.
St
ep-
2 Sel
ecttheprojectwi
thhigherEABorlowerEAC.

Not
e:cal
cul
ati
onofi
ncr
ement
albenef
itandi
ncr
ement
alout
fl
owar
edi
scussedi
nthecl
asses.

Chapt
er-
|Capi
tal
Budget
ing 5
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

PRACTI
CALPROBLEMS

Pr
ob.
1
Aproj
ecthasani ni
ti
ali
nvest
mentof`1,
00,
000.Itwi
l
lproduceCashFl
owsaf
tert
axof`25,
000p.
a.
f
orsevenyear
s.ComputethePay
backPer
iodfort
heproj
ect
.

Ans.
4year
s

Pr
ob.
2
ProjectKhasaninit
ial
inv
est
mentof`10lakhs.I
tsCashFlowsf
orfi
veyear
sar
e`3,
00,
000,`3,
60,
000,
`3,00,000,`2,
64,
000and`2,40,
000.
Det
erminethePaybackPer
iodassumi
ngadi
scountr
ateof10%
p.
a.

Ans.4.
16y
ear
s

Pr
ob.
3
a) Comput
eARRi
fcostofandasseti
s`2,
00,
000,
Usef
ull
i
fe–5y
ear
s,CashFl
owaf
terTax`86,
000
p.
a.

b) ProjectLr
equi
resani
nvest
mentof`10l
akhsandy
iel
dspr
ofi
taf
tert
axanddepr
eci
ati
onas
fol
lows:

Year 1 2 3 4 5
Prof
itaf
terTaxandDepr
eci
ati
on(
`) 50,
000 75,
000 1,
25,
000 1,
30,
000 80,
000

Att
heendof5y
ear
s,t
hepl
antcanbesol
dfor`80,
000.

Youar
erequi
redt
ocal
cul
ateARR.

Ans:(
a)23%;
(b)10%

Pr
ob.
4
ALtdisconsi
der
inganew 5y
earpr
oject
.It
sinv
est
mentcost
sandannualpr
ofi
tsar
epr
oject
edas
f
oll
ows:

I
nvest
ment Pr
ofi
ts
Year 0 1 2 3 4 5
Amount(
`) (2,
50,
000) 40,
000 30,
000 20,
000 10,
000 10,
000

Resi
dualVal
ueatt
heendoftheproj
ecti
sexpect
edt
obe`40,
000andDepr
eci
ati
onoft
heor
igi
nal
i
nvest
mentisonst
rai
ghtl
i
nebasi
s.

Usi
ngAverageProf
it
sandAv
erageCapi
talEmpl
oyed,cal
cul
ateARRf
ort
hepr
ojectandal
sot
he
pay
backperi
od.

Ans:(
a)ARR:
15.
17%,
10.
48%;
(b)7.
85mont
hs,
3.65y
ear
s

Pr
ob.
5
NewThought
sCompanyi
sev
aluat
ingani
nvest
mentpr
oposalof`3,
06,
000wi
thexpect
edcashf
lows
as:

Year 1 2 3 4
CFAT(`
) 1,
00,
000 1,
20,
000 1,
50,
000 1,
00,
000

TheCompany
’sCostofCapi
tal
is10%.

Comput
etheNPVandPIf
ort
hispr
oject
.

Ans:NPV`73,
337;
PI–1.
24

Chapt
er-
|Capi
tal
Budget
ing 6
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Pr
ob.
6
Bhi
lwaraCo.’
scostofcapitali
s10%andi tissubjectto50%t axrat
e.Thecompanyisconsideri
ng
buyi
nganewf ishi
ngmachine.Themachinewillcost`2lakhsandwillr
educemat
eri
alswastebyan
est
imatedamountof`50,000ay ear
.Themachi newil
llastfor10y
earsandwil
lhaveazerosalvage
val
ue.Assumestrai
ghtl
i
nemet hodofdepreci
ati
ononasset .

a) Comput
etheAnnual
CashI
nfl
ows,
PresentVal
ue,
NetPr
esentVal
ueandPr
ofi
tabi
l
ityI
ndex.

b) Shoul
dthecompanypur
chaset
henewf
ishi
ngmachi
ne?

Ans:CFAT`35,
000;
NPV`15,
061;
PI–1.
075

Pr
ob.
7
Acompanyproposestoi
nstallamachi
neinvolv
ingacapital
costof`3,
60,
000.Thel
ifeofthemachine
i
s5y ear
sanditssal
vagevalueatt
heendoft heli
fei
snil.Themachinewi
llpr
oducethenetoper
ating
i
ncomeaf t
erdepr
eci
ati
onof`68,000p.a.Thecompany’sTaxRateis45%.ThePVf act
orsfor5years
i
sasunder:

Di
scounti
ngFactor 14 15 16 17 18
Cumulat
iveFact
or 3.43 3.35 3.27 3.20 3.13

Cal
cul
ateI
RRoft
hepr
oposal
.

Ans:I
RR15.
74%

Pr
ob.
8
Acompanyi sconsideri
ngaproposalofi
nstall
ingaDryi
ngEquipment.Theequipmentwoul dinv ol
vea
cashoutlayof`6,00,000andNetWor kingCapitalof`80,
000.Theex pectedli
feofthepr ojectis5
yearswit
houtanysal v
ageval
ue.Assumet hatthecompanyi sal
lowedt ochar gedepreciati
onon
str
aightl
i
nebasisforincometaxpurposes.Theestimat
edbeforet
axcashi nfl
owsaregivenbel ow:

Year 1 2 3 4 5
Befor
eTaxCashI
nfl
ows(
`’000) 240 275 210 180 160

Theappl
i
cabl
eincomet
axr
atet
othecompanyi
s35%.

I
fthecompany’sopportuni
tycostofcapi
tali
s12%,cal
cul
atet
heequi
pment
’s– (
a)Di
scount
ed
pay
backper
iod;
(b)Paybackperi
od;(
c)NPVand(d)I
RR

Ans:(
a)4.
77y
ear
s;(
b)3.
52y
ear
s;(
c)`29,
109;
(d)13.
74%

Pr
ob.
9
CLtdisconsider
ingi
nvest
ingi
napr oj
ect.Theexpect
edinvestmenti
ntheproj
ectwi
llbe`2,
00,
000
wit
hprojectl
if
eof5y ear
sandnosal vageval
ue.TheexpectedNetCashInf
lowsaft
erDepr
eci
ati
on
butbef
oretaxduri
ngt
helif
eofthepr
ojectwil
lbe:

Year 1 2 3 4 5
` 85,
000 1,
00,
000 80,
000 80,
000 40,
000

ThePVFact
orsar
e:

Year PVat10% PVat37% PVat38% PVat40%

1 0.
909 0.
730 0.
725 0.
714
2 0.
826 0.
533 0.
525 0.
510
3 0.
751 0.
389 0.
381 0.
364
4 0.
683 0.
284 0.
276 0.
260
5 0.
621 0.
207 0.
200 0.
186

Chapt
er-
|Capi
tal
Budget
ing 7
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Theprojectwi
l
lbedepr
eci
atedatt
her
ateof20%onor
igi
nalcost
.Thecompanyi
ssubj
ect
edt
o30%
TaxRate.

Cal
cul
ate–(
a)Pay
backPer
iod;
(b)ARR;
(c)NPVandNPVI
ndex,
ifcostofcapi
tal
is10%;
(d)I
RR.

Ans:(
a)1.
91y
ear
s;(
b)26.
95%;
(c)NPV`1,
61,
198;
PI–1.
81;
(d)39.
91%

Pr
ob.
10
Themanagementofacompanyhastwoalt
ernat
ivepr
oposalsunderconsi
derat
ion.Proj
ectArequir
es
capi
talout
layof`12,
00,
000andpr
ojectBr
equir
es`18,00,
000.Bothareesti
mat edtoprovi
deacash
fl
owf orf
iveyear
sasProj
ectA`4,
00,
000peryearandProj
ectB`5,80,000peryear.Costofcapi
tali
s
10%.

Show whi
chofthet
woproj
ect
sispref
erabl
efr
om t
hev
iewpoi
ntof–(
a)NPVMet
hod;(
b)Pr
esent
Val
ueIndexMet
hodand(
c)I
RRMethod.

Ans:(
a)NPV:A`3,
16,
400;
B`3,
98,
780;
(b)PI
:A–1.
26,
B–1.
22;
(c)I
RR:A19.
87%;
B18.
35%

Pr
ob.
11
Acompanyhastomakeachoi cebetween2pr
oject
snamelyAandB.theinit
ial
outl
ayofAandBare`
1,
35,
000and`2,40,
000respecti
vel
ywithnoscrapval
ue.Thecostofcapi
talofthecompanyi
s16%.
Theannual
incomesar
e:

Year 1 2 3 4 5

Pr
ojectA(
`) - 30,
000 1,
32,
000 84,
000 84,
000
Pr
ojectB(
`) 60,
000 84,
000 96,
000 1,
02,
000 90,
000
DFat16% 0.
862 0.
743 0.
641 0.
552 0.
476

Cal
cul
atef
oreachpr
oject–(
a)Di
scount
edPay
backPer
iod;
(b)PIand(
c)NPV

Ans:(
a)A3.
61y
ear
s,B4.
19y
ear
s;(
b)PI
:A–1.
43,
B–1.
15;
(c)NPV:A`58,
254;
B`34,
812

Pr
ob.
12
PR Engineer
ing Lt
disconsideri
ng thepur
chaseofa new machi
newhi
ch wil
lcarr
youtsome
oper
ati
onswhi chareatpr
esentperf
ormedbymanuall
abour
.Thef
oll
owi
ngi
nfor
mationr
elat
edt
othe
twoalt
ernati
vemodels–‘MX’and‘MY’ ar
eav
ail
abl
e:

Machi
ne‘
MX’ Machi
ne‘
MY”

CostofMachine `8,
00,
000 `10,
20,
000
Expect
edLif
e 6years 6years
ScrapVal
ue `20,
000 `30,
000

Est
imat
edNetI
ncomebef
oreDepr
eci
ati
onandt
axar
easunder
:

Machi
ne Year1 Year2 Year3 Year4 Year5 Year6
MX(`) 2,
50,
000 2,
30,
000 1,
80,
000 2,
00,
000 1,
80,
000 1,
60,
000
MY(`) 2,
70,
000 3,
60,
000 3,
80,
000 2,
80,
000 2,
60,
000 1,
85,
000

Cor
porat
eTaxRateforthi
scompanyi
s30%andthecompany
’srequi
redr
ateofr
etur
noni
nvest
ment
pr
oposal
sis10%.Depr
eciat
ionwi
l
lbechar
gedonst
rai
ghtl
i
nebasis.

Youar
erequi
redt
o:

a) Cal
cul
atet
hePay
backPer
iodofeachpr
oposal
.

b) Cal
cul
atet
heNetPr
esentVal
ueofeachpr
oposal
,ift
hePVFact
orat10%i
s0.
909,0.
826,0.
751,

Chapt
er-
|Capi
tal
Budget
ing 8
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

0.
683,
0.621and0.
564.

c) Whi
chpr
oposal
youwoul
drecommendandwhy

Ans:(
a)MX–4.
25y
ear
s,MY–3.
67y
ear
s;(
b)NPV:MX`4,
807;
MY`1,
12,
090

Pr
ob.
13
Consi
dert
hef
oll
owi
ngmut
ual
l
yexcl
usi
vepr
oject
s:

CashFl
ows(
`)
Pr
oject
s C0 C1 C2 C3 C4

A (
10,
000) 6,
000 2,
000 2,
000
12,
000
B (
10,000) 2,
500 2,
500 5,
000 7,
500
C (
3,500) 1,
500 2,
500 500 5,
000
D (
3,000) 0 0 3,
000 6,
000

Requi
red:

a) Cal
cul
atet
hePay
backPer
iodf
oreachpr
oject
.

b) Ifthest
andar
dpay backperi
odis2year
s,whi
chpr
ojectwi
l
lyousel
ect
?Wi
l
lyouranswerdi
ff
er,i
f
standar
dpaybackperiodi
s3y ear
s?

c) I
fthecostofcapi
tali
s10%,comput
ethediscount
edpay backperi
odforeachproject.Whi
ch
pr
ojectwi
l
lyour
ecommend,i
fst
andar
ddi
scountedpaybackperi
odis–(i
)2years,
(ii
)3y ear
s?

d) ComputeNPVofeachproj
ect
.Whichproj
ectwil
lyour
ecommendont heNPVcr
it
eri
on?Thecost
ofcapi
tal
is10%.Whatwi
ll
betheappr
opri
atechoi
cecr
iter
iai
nthi
scase?

Year 1 2 3 4
PVFact
orat10% 0.
9091 0.
8264 0.
7513 0.
6830

Ans:NPV:A`6,
807;
B`3,
219;
C`3,
721;
D`3,
352;
PI:A–1.
68,
B–1.
32,
C–2.
06,
D–2.
19

Pr
ob.
14
Thedirect
orofDamonElect
roni
csCohasaskedyouanaly
set
wopr oposedi
nvest
ment
sProj
ectX
andY.eachpr oj
ecthasaninit
iali
nvest
mentof`10,
000atacostof12%.TheCashFlowsare
expect
edasunder:

Year 1 2 3 4
CashFl
owsofX(
`) 6,
500 3,
000 3,
000 1,
000
CashFl
owsofY(
`) 3,
500 3,
500 3,
500 3,
500

a) Cal
cul
atef
oreachpr
oject–(
i)Si
mpl
ePay
backPer
iod,
(ii
)NPVand(
ii
i)I
RR.

b) Whi
chpr
ojectshoul
dbeaccept
edi
fthepr
oject
swer
eindependent
?

c) Whi
chpr
ojectshoul
dbeaccept
edi
ftheywer
emut
ual
l
yexcl
usi
ve?

Ans:X–NPV:12%`967,
20%(
`283)
;IRR18.
19%;
Y–NPV:12%`630,
20%(
`940)
;IRR15.
21%

Pr
ob.
15
ThemanagementofPLt di
sconsi
deri
ngtosel
ectamachineoutoft
hetwomutual
l
yex cl
usi
ve
machi
nes.Thecompany’
scostofcapi
tali
s12% andcor
porat
etaxrat
eis30%.Detai
l
soft he
machi
nesareasf
oll
ows:
MachineI Machi
neII

Chapt
er-
|Capi
tal
Budget
ing 9
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Costofmachine `10,
00,000 `15,
00,
000
Expect
edli
fe 5years 6y
ear
s
Annuali
ncomebefor
eTax&Depr
eci
ati
on `3,
45,
000 `4,
55,
000

Depr
eci
ati
oni
stobechar
gedonst
rai
ghtl
i
nebasi
s.

Youar
erequi
redt
o:

a) Cal
cul
atet
heDi
scount
edPay
backPer
iod,
NetPr
esentVal
ueandI
nter
nalRat
eofRet
urnf
oreach
machi
ne.

b) Adv
icet
hemanagementofPLt
dast
owhi
chmachi
neshoul
dtakeup.

Ans:Pay
back:I–4.
49y
rs,
II–5.
41y
rs;
NPV:I`86,
909;
II`1,
18,
074;
IRR:
I15.
46%;
B14.
74%

Pr
ob.
16
XYZLt displanni
ngtoint r
oduceanewpr oductwit
hapr ojectli
f eof8y ears.Thepr oj
ectistobeset
upinSpeci alEconomicZone( SEZ),qualifi
esforonetime( atstarti
ng)taxf r
eesubsidyfrom theState
Gov ernmentof`25, 00,000 on capitali nvest
ment.I nit
ialequi pmentcostwi l
lbe`1. 75 crores.
Addi t
ionalequipmentcosting`12,50,000wi l
lbepurchasedatt heendoft hethir
dy earfr
om t hecash
i
nflow oft hi
sy ear
.Att heendof8y ears,theori
ginalequi pmentwi l
lhav enor esalevalue,butthe
additi
onalequipmentcanbesol dfor`1,25,000.Awor kingcapi talof`20,00,000willbeneededandi t
wil
lber el
easedattheendofei ght
hy ear.Thepr oj
ectwillbef i
nancedwi t
hsuf fi
ci
entamountofEqui ty
Capital.Thesalesvol
umesov ereighty earshavebeenest imat edasf ol
lows:

Year 1 2 3 4–5 6–8

Unit
s 72,
000 1,
08,
000 2,
60,
000 2,
70,
000 1,
80,
000

Asalespriceof`120peruniti
sexpectedandvari
ableexpenseswi l
lamountto60%ofsalesrevenue.
Fixedcashoperati
ngcostswil
lamount`18,00,
000pery ear.Thelossofanyyearwil
lbesetofffrom
theprofi
tsofsubsequentt
woy ear
s.Thecompanyissubj ectto30%t axrat
eandconsi
ders12%t obe
anappropriat
eaftert
axcostofcapit
alfort
hisproj
ect.Thecompanyf ol
l
owsStrai
ghtLi
neMet hodof
depreci
ati
on.

Calcul
atetheNetPr
esentVal
ueoft
hepr
ojectandadv
icet
hemanagementt
otakeappr
opr
iat
e
decisi
on.

Year 1 2 3 4 5 6 7 8
PVFact
orsat12% 0.
893 0.
797 0.
712 0.
636 0.
567 0.
507 0.
452 0.
404

Ans:NPV`101.
05l
akhs

Pr
ob.
17
Moder nEnt erprisesLt di sconsideri
ngt hepurchaseofanewcomput ersy st
em forit
sR&Ddi v i
si
on,
whichwoul dcost`35l akhs.Theoper at i
onandmai ntenancecost s( excl
udingdepreciat
ion)are`7
l
akhsp. a.Iti sest imatedt hattheusef ulli
feofthesy stem wouldbe6y earsattheendofwhi cht he
scrapvaluewi ll
be`1l akh.Thet angiblebenefi
tsexpectedf r
om thesy stem intheform ofr
eductionin
designanddr aught smanshi pcostswoul dbe`12l akhsp. a.Besides,thedi sposalofuseddr awing
off
iceequi pmentandf urnit
ureiniti
all
yi sexpectedtonet`9l akhs.Capi talexpendi
tureinR&Di s
el
igibl
ef or100%wr it
e-offfortaxpur poses.Thegainsar isi
ngfrom di sposalofusedasset smaybe
consideredt axf ree.Thecompany ’
staxr atei
s50%andcostofcapi talis12%.

Af
terappr
opr
iat
eanal
ysi
sofcashf
lows,
adv
icet
hecompanyoft
hef
inanci
alv
iabi
l
ityoft
hepr
oposal
.

Ans:NPV`0.
42l
akhs

Pr
ob.
18

Chapt
er-
|Capi
tal
Budget
ing 10
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

NineGemsLt dhasjustinstall
edMachineRatacostof`2l akhs.Themachi nehasa5yearli
fewit
h
nor esi
dualval
ue.Theannualv ol
umeofproduct
ionisesti
matedat1, 50,
000unit
s,whi
chcanbesold
at`6peruni t.Annualoper at
ingcost
sareesti
mat edat`2l akhs( excl
udi
ngdepreci
ati
on)atthi
s
outputlev
el.Fi
xedcostsar eestimat
edat`3perunitfort
hesamel evelofpr
oducti
on.

Thecompanyhasj ustcomeacrossanothermodelMachineS,capableofgivi
ngthesameoutputat
anannualoperat
ingcostof`1.80lakhs(excl
udi
ngdepr eci
ati
on).Ther
ewillbenochangeinfixed
cost
s.MachineScosts`2.50l
akhs,i
tsresi
dual
valuewi
llbenilaft
erauseful
li
feof5years.

Ni
neGemsLt dhasanofferf
orsal
eofMachi
neRfor`1,
00,
000.Thecostofdi
smant
li
ngandremoval
wi
llbe`30,000.Asthecompanyhasnoty
etcommencedoperat
ions,
itwant
stodi
sposeofMachi
ne
Randinst
allMachineS.

Thecompanywil
lbeazero-t
axcompanyforsev
enyear
sinvi
ewofsever
ali
ncent
ivesandal
l
owances
avai
l
abl
e.Thecostofcapi
tali
s14%andthePVFact
orsareasunder
:

Year 1 2 3 4 5
PVFact
orat14% 0.
877 0.
769 0.
675 0.
592 0.
519

Advi
cewhetherthecompanyshoul
doptforrepl
acement
.Will
youranswerbedi
ff
erenti
fthecompany
hasnoti
nst
alledMachineRandisi
ntheprocessofsel
ect
ingeit
herRorS?

Ans:NPV:R`6,
58,
000;
S`6,
76,
640

Pr
ob.
19
Bet
aElect
roni
csisconsi
der
ingapr
oposalt
orepl
aceoneofi
tsmachi
nes.Thef
oll
owi
ngi
nfor
mat
ion
i
savai
l
abletoyou.

Theexi st
ingmachi newasbought3y earsagof or`10lakhs.I twasdepreci
atedat25% p.a.on
reduci
ngbal ancebasis.I
thasremai
ningusefulli
feof5y ears,butit
sannualmaint
enancecostis
expectedtoincreaseby`50,
000fr
om thesixt
hyearofit
sinstall
ati
on.It
spr
esentreal
i
sableval
ueis`
6lakhs.Thecompanyhassev er
almachines,
having25%depreciat
ion.

Thenew machinecost
s`15lakhsandi
ssubj
ectt
othesamer
ateofdepr
eci
ati
on.Onsal
eaf
ter5
year
s,i
tisexpect
edtonet`9l
akhs.

Witht
henewmachine,theannualoper
ati
ngcosts(excl
udi
ngdepreci
ati
on)ar
eexpect
edtodecr
ease
by`1l akh.I
nadditi
on,thenew machi newouldincr
easeproducti
vi
tyonaccountofwhichnet
rev
enueswoul
dincr
easeby`1.5lakhsannual
l
y.

Thet
axr
ateappl
i
cabl
etot
hecompanyi
s35%andt
hecostofcapi
tal
is10%.

Adv
icet
hecompany
,ont
hebasi
sofNPVoft
hepr
oposal
,whet
hert
hepr
oposal
isf
inanci
all
yvi
abl
e.

Ans:NPV`(
25,
447)

Pr
ob.
20
BetaCompanyLt disconsideri
ngreplacementofitsexi
sti
ngmachi nebyanew machi ne,whichis
expectedtocost`2,64,
000.Thenewmachi newillhav
ealif
eoff i
vey ear
sandwilly
iel
dannualcash
revenuesof`5,68,
750andi ncurannualcashexpensesof`2,95,
750.Theesti
matedsalvageval
ueof
thenewmachi neis`18,200.Theexisti
ngmachinehasabookv al
ueof`91,000andcanbesol dfor`
45,500today
.

Theexisti
ngmachinehasaremaini
ngusefull
i
feof5year
s.Thecashrevenueswi
llbe`4,
55,
000and
associ
atedcashexpenseswi
llbe`3,
18,
500.Theexi
sti
ngmachi
newillhaveasal
vageval
ueof`4,
550
attheendof5years.

TheBet
aCompanyi
sin35%t
axbr
acket
,andwr
it
esof
fdepr
eci
ati
onat25%onWDVMet
hod.

Chapt
er-
|Capi
tal
Budget
ing 11
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

TheBet
aCompanyhasat ar
getDebttoval
uer
ati
oof15%.Thecompanyi
nthepasthasr
aiseddebt
at11%andi
tcanr
aisef
reshdebtat10.
5%.

BetaCompanyplanstofol
l
owdi v
idenddi
scountmethodtoesti
matethecostofequit
ycapi
tal
.The
companyplanstopayadi vi
dendof`2pershar einthenextyear
.Thecurrentmarketpri
ceof
company’
sequityshar
eis`20perequityshare.Thedivi
dendperequi
tyshar
eoft hecompanyis
expect
edtogrowat8%.

Requi
red:

a) ComputetheIncrement alCashFl owsofther eplacementdeci si

on.
b) ComputetheWei ght
edAv er
ageCostofCapi talofthecompany .
c) Fi
ndouttheNetPr esentVal ueoft herepl
acementdeci sion.
d) Est
imatetheDiscountedPay backPeriodofther eplacementdecisi
on.
e) Shoul
dthecompanyr eplacet heexist
ingmachi ne?Adv ice.

Ans:Addi
ti
onalNPV`1,
15,
827

Pr
ob.
21
Acompanywhichi
sinthe40%taxbracket
,hast
opurchaseanyoneoftwomachi
nesPandQf
orone
ofi
tsf
act
ori
es.Thefol
l
owingdetai
l
sareavail
abl
einr
espectofthetwomachi
nes:
P Q

Costofmachine(
includi
nginstal
l
ati
oncost
s) `20,
00,
000 `36,
00,000
Useful
li
fe 5year
s8y ears
Cashoperat
ingexpensesforthemachi
ne `6,
00,
000 `3,
40,
000

The appropri
ate di
scountratef orthe company is 12%.Usi
ng appr
opriate ev
aluat
ion cr
it
eri
on,
deter
minewhi chmachineshouldbepurchased.Assumecashf l
owstoperpetui
tyandthatthecostof
removaloftheasset
satt heendofthei
rusefull
if
ewi l
lequal
thei
rsal
vagevalues.

Ans:EAC:
P`(
7,54,
815)
;Q`(
7,48,
696)

Pr
ob.
22
Acompanywhi chi
sinthe40%taxbracket
,hast
opurchaseanyoneoft
womachinesLandM f
orone
ofi
tsf
actor
ies.Thefol
l
owingdetai
l
sar eavai
l
abl
einr
espectofthetwomachi
nes:
L M

Costofmachine( i
ncl
udinginst
all
ati
oncost
s) `20,
00,
000 `36,
00,000
Useful
li
fe 5year
s8y ears
Netoperat
ingincome( bef
oredepreci
ati
on)
fr
om useofthemachi ne `6,
00,
000 `8,
40,
000

Theappr
opr
iat
edi
scountr
atef
ort
hecompanyi
s12%.

a) Usingappropri
ateeval
uati
oncr i
ter
ion,det
ermi
newhichmachineshoul
dbepurchased.Assume
cashf l
owstoperpetui
tyandthatthecostofremov
aloftheasset
sattheendoftheirusef
ull
if
e
wil
l equal
thei
rsalv
agev al
ues.

b) Woul
dy ouranswerto(a)abovebedi
ff
erent
,ifNetOper
ati
ngI
ncomesofmachi
neM wer
e`
8,
80,
000inst
eadof`8,
40,000?

Ans:EAC:
L`(
34,
815)
;M `(
40,
696)

Pr
ob.
23
CompanyUVW hast
omakeachoicebetweentwoidenti
cal
machines,
int
ermsofcapaci
ty,
‘A’
and‘
B’.
Theyhav
ebeendesi
gneddi
ff
erent
ly,
butdoexact
lythesamejob.

Machi
ne‘
A’cost
s`7,
50,
000andwi
l
llastf
ort
hreey
ear
s.I
tcost
s`2,
00,
000pery
eart
orun.Machi
ne‘
B’

Chapt
er-
|Capi
tal
Budget
ing 12
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

i
saneconomymodelcost
ingonl
y`5,
00,
000,butwi
l
llastf
oronl
ytwoy
ear
s.I
tcost
s`3,
00,
000per
y
eart
orun.

Thiscashfl
owsofmachine‘A’and‘B’arerealcashflows.Thecostsarefor
ecast
edi
nrupeesof
const
antpur
chasi
ngpower.I
gnor
etaxes.Theopportuni
tycostofcapi
tal
is9%.

Whi
chmachi
net
hecompanyUVW shoul
dbuy
?Thepr
esentv
aluef
act
orsat9%ar
e:

Year T1 T2 T3
PVfact
orat9% 0.
9174 0.
8417 0.
7722

Ans:Tot
alout
fl
owp.
a.:A`4,
96,
290;
B`5,
84,
236

Pr
ob.
24
Acompanyhast omakeachoicebetweentwomachinesXandY.Thet
womachi
nesar
edesi
gned
di
ff
erent
ly,
buthavei
dent
ical
capaci
tyanddoexact
lyt
hesamejob.

MachineXcost
s`5,50,
000andwil
llastf
or3years.I
tcost
s`1,25,000peryeartorun.Machi
neYisan
economymodelcosti
ng`4,
00,
000,butwil
ll
astf
oronlytwoyears.Itcost
s`1,50,
000peryeartor
un.

Thesearerealcashf l
ows.Thecost
sar
efor
ecast
ed i
nrupeesofconst
antpur
chasi
ngpower
.
Oppor
tuni
tycostofcapi
tal
is12%.

Whi
chmachi neshoul
dthecompanybuy ?I
gnor et axes.Gi
ven:PVI
F0.12,1 =0.
8929,PVI
F0.12,2 =0.
7972,
PVI
F0.12,3=0.
7118,
PVIFA0.12,2=1.
6901,
PVIFA0.12,3=2.4019

Ans:Equi
val
entannualout
fl
ow:X`3,
53,
985;
Y`3,
86,
672

Pr
ob.
25
Af i
rm canmakeinvest
mentineit
herofthefol
lowi
ngt
woproject.Thefir
m anti
ci
pat
esitscostof
capi
taltobe10%andthenet(
aft
ertax
es)cashfl
owsoft
hepr
ojectsforf
iveyear
sareasfol
l
ows:

Year 0 1 2 3 4 5
Proj
ectA (
5,00,000) 85,
000 2,
00,
000 2,
40,
000 2,
20,
000 70,
000
Proj
ectB (
5,00,000) 4,
80,
000 1,
00,
000 70,
000 30,
000 20,
000

Thedi
scountf
act
orsar
easunder
:

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

a) Calcul
atetheNPVandI RRofeachproj
ect
.
b) Statewit
hr easonswhi chproj
ectyouwoul
drecommend.
c) Explai
nthei nconsi
stencyinranki
ngoftwopr
oject
s.

Ans:A:
NPV:
10%`116.
35,
20%`(
17.
95)
;IRR18.
66;
B:NPV:10%`105.
1,20%`30.
6;I
RR25.
68

Pr
ob.
26
Thecashf
lowsofpr
oject
sCandDar
egi
venbel
ow:

Pr
oject C0 C1 C2 C3 NPVat10% I
RR
C(`
) (
10,000) 2,
000 4,000 12,
000 4,
139 26.
5%
D(`
) (
10,000) 10,
000 3,000 3,
000 3,
823 37.
6%

a) Whyi
sthereaconfl
icti
nranki
ngs?
b) Whyshoul
dyourecommendPr oj
ectCi
nspi
teofl
owerI
RR?

Ti
me 1 2 3

Chapt
er-
|Capi
tal
Budget
ing 13
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

PVI
F–0.
10 0.
9090 0.
8264 0.
7513
PVI
F–0.
14 0.
8772 0.
7695 0.
6750
PVI
F–0.
15 0.
8696 0.
7561 0.
6575
PVI
F–0.
30 0.
7692 0.
5917 0.
4552
PVI
F–0.
40 0.
7143 0.
5102 0.
3644

Ans:I
RR:C–26.
5%,
D–37.
6%

Pr
ob.
27
Fol
l
owi
ngar
ethedat
aonaCapi
tal
Proj
ect(
Proj
ectM)bei
ngev
aluat
edbyt
hemanagementofXLt
d:

Annual costofsavi
ng `40,
000
Usefulli
fe 4years
I
.R.R 15%
Profi
tabil
it
yI ndex(
PI) 1.
064
NPV ?
CostofCapi tal ?
CostofPr oject ?
Payback ?
Salv
ageVal ue 0

Fi
ndt
hemi
ssi
ngv
alueconsi
der
ingt
hef
oll
owi
ngt
abl
eofdi
scount
ingf
act
oronl
y:

Di
scountf
act
or 15% 14% 13% 12%

1stYear 0.
869 0.
877 0.
885 0.
893
2ndYear 0.
756 0.
769 0.
783 0.
797
3rdYear 0.
658 0.
675 0.
693 0.
712
4thYear 0.
572 0.
592 0.
613 0.
636

2.
855 2.
913 2.
974 3.
038

Ans:CostofPr
ojectM:`1,
14,
200;
Pay
back:2.
855Year
s;CostofCapi
tal
:12%;
NPV:`7,
309

Pr
ob.
28
Acompanyi seval
uat i
ngani nvest
mentpr ojectwhichrequir
esani ni
ti
alcashout l
ayof`2, 50,000on
Equi
pment .Thepr oject
’seconomi cl
ifeis10y earsandi t
ssal vagev alue`30,000.Itwoul dr equi
re
Curr
entAsset sof`50,000.Anadditi
onalinvestmentof`60,000woul dalsobenecessar yatt heendof
fi
veyearst orest
or etheeffi
ciencyoftheequi pment.Thiswoul dbewr itt
enoffcompl etel
yov erthe
l
astfiv
ey ears.Thepr ojecti
sexpectedt oy iel
dAnnual( Bef
or eTax )CashI nfl
ow of`1, 00,000.The
companyf oll
owst hesum oft heyears’digi
tmet hodofdepr eciat
ion.Income-taxr at
eisassumedt o
be40%.

Shoul
dthepr
ojectbeaccept
edi
fthemi
nimum r
equi
redr
ateofr
etur
nis20%?

Ans:NPV`(
6,662)

Pr
ob.
29
SubhojitLtdhasamachi nehavinganadditi
onallif
eof5Year s,whichcosts`10, 00,
000andhasa
bookv alueof`4,00,
000.Anew machi necosti
ng`20, 00,000isavail
able,t
houghi tscapacit
yi sthe
sameast hatofol
dmachine,i
twi l
lmeanasavinginv ar
iablecoststotheextentof`7,00,
000p.a.The
l
ifeofmachi newil
lbe5y ear
satt heendofwhi chitwil
lhav eascrapv al
ueof`2, 00,
000.Ther ateof
i
ncomet axis50%andSubhojitLtd,pol
icyi
snott omakeani nvest
menti fy
ieldislessthan12%p. a.
Theol dmachine,i
fsol
dtoday,willr
eali
ze`1,
00,000.Itwil
lhavenosal vagevalueifsoldattheendof
5thYear.

Adv
iseSubhoj
i
tLt
d,whet
herornott
heol
dmachi
neshoul
dber
epl
aced.

Chapt
er-
|Capi
tal
Budget
ing 14
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

Ans:NPVofbenef
it
s`1,
29,
850

Pr
ob.
30
CompanyDi sforcedt ochoosebet weentwomachi nesAandB.Thet womachi nesar edesigned
dif
ferentl
y,buthav eident
icalcapaci
tyanddoex act
lythesamejob.Machi neAcost s`1, 50,000and
wil
llastfor3y ear
s.Itcosts`40,000peryeartorun.Machi
neBi san“economy ”modelcost i
ngonly`
1,
00,000,butwi l
llastonlyfor2y ear
s,andcosts`60,000pery
eartor un.Thesearer ealcashf l
ows.
Thecost saref or
ecast edinrupeesofconstantpurchasi
ngpower.Ignoret ax.Opportunitycostof
capit
al i
s10%.

Whi
chmachi
neCompanyDshoul
dbuy
?

Ans:EAC:
A`1,
00,
314;
B`1,
17,
604
Pr
ob.
31
Acompanyhasj ustinst
all
edamachi neModel Aforthemanufactureofanewpr oductat
capit
al costof`1,00,
000.Theannual oper
at i
ngcostsareesti
matedat` 50,000(excludi
ng
depreciati
on)andt hesecost sar
eestimatedont hebasisofanannual vol
umeof1, 00,
000
unit
sofpr oduction.Thefixedcostsatthi
sv olumeof1,00,
000uni t
sofout putwil
l amountto
`4,
00,000p. a.Theselli
ngpriceis`5perunitofoutput
.Themachi nehasaf i
veyearlif
ewith
no
resi
dual value.
Thecompanyhasnowcomeacr ossanot
hermachi necall
edSuperModel whichiscapable
ofgiving,thesamev olumeofpr oducti
onatanest imatedannualoperati
ngcostsof` 30,
000

exclusiveofdepr eciation.Thef ixedcost swi l

lhowev er,remai nthesamei nv alue.This
machi neal sowi llhav eaf iv
ey earli
fewi t
hnor esidual v
al ue.Thecapi t
al costoft hismachi ne
i
s` 1,50,000.
Thecompanyhasanof ferforthesal eoft hemachi neModel A(whi chhasj ustbeen
i
nst all
ed)at` 50, 000andt hecostofr emov althereofwi llamountt o` 10,000.I gnor etax.
Inviewoft hel oweroper ati
ngcost ,thecompanyi sdesi rousofdi smant lingoft hemachi ne
Model Aandi nst all
i
ngt heSuperModel Machine.Assumet hatModel Ahasnoty etstarted
commer ci
al product ionandt hatthet imelagi nt her emov al t
hereofandt hei nstall
ati
onof
theSuperModel machi neisnotmat erial
.
Thecostofcapi talis14%andt heP. V.Fact or
sf oreachoft hefivey ear sr espect i
velyare
0.877, 0.769, 0.675, 0.592and0. 519.
Statewhet hert hecompanyshoul drepl aceModel Amachi nebyi nstallingt heSuperModel
machi ne.Wi l
l therebeanychangei ny ourdeci si
oni ftheModel Amachi nehasnotbeen
i
nst all
edandt hecompanyi sinthepr ocessofconsi derationofsel ectionofei theroft hetwo
model soft hemachi ne?Pr esentsuitabl estat
ementt oill
ust r
ateyouranswer

Ans.Choosesupermodel
.

Pr
ob.32

ACompanyi sconsi deri

ngtwomut uallyexclusi
vepr oj
ects.Pr oj
ectKwi l
lrequir
eani ni
tial
cash
i
nv estmentinmachi ner
yof`2,68,000.Itisant i
cipatedt hatthemachi ner
ywi ll
hav eauseful
l
ifeoft enyearsatt heendofwhi chi t
ssalvagewi ll
reali
se` 20,500.Thepr ojectwillal
so
require
anaddi ti
onali
nv estmentincash, Sundrydebt orsandst ockof` 40,000.Att heendoff i
ve
yearsf r
om thecommencementoft heprojectbal ancingequi pmentf or`45,000hast obe
i
nst all
edtomaket heunitworkable.Thecostofaddi ti
onal machiner ywil
lbewr i
tt
enof fto
depr eci
ati
onov erthebalanceli
feoft hepr oj
ect.Thepr ojectisex pectedtoy i
eldanetcash

Chapt
er-
|Capi
tal
Budget
ing 15
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

flow( befor edepreci at i

on)of` 1,
00,000annual ly.
Pr ojectR, whichist heal t
ernativeoneunderconsi derat
ion,requi r
esani nv estmentof
`3,00, 000i nmachi ner yandasi nPr ojectKinv estmentincur rentasset sof` 40,000.The
residual
sal vagev alueoft hemachi neryatt heendofi tsusefull
ifeoft eny ear sisexpect edtobe
`25,000.Theannual cashinf l
ow( beforedepr eciati
on)from thepr ojectiswor kedat` 80,000
p.a.f ort hef i
rstfivey earsand` 1,80,000perannum f orthenex tfi
v ey ears.
Depr eciationi swrittenof fbyt heCompanyonsum- of-t
hey ear s‘digit
smet hod,(i
.e.
,iftheli
fe
oft heasseti s10y ear s,
theni nther atioof10, 9,8andsoon) .Incomet axr at
eis50%.A
mi nimum r at
eofr et ur nhasbeencal culatedat16%.Thepr esentv al
ueof`1ati nterestof
16%p. a.is0. 86,0.74, 0.
64, 0.
55, 0.
48, 0.41,0.35,0.30,0.26and0. 23f oryear s1to10
respect i
v ely.

WhichProj
ecti
sbet
ter
?Assumi
ngnocapi
tal
gai
nst
axes,
cal
cul
atet
heNetPr
esentVal
ueof
eachProj
ect

Pr
ob.33

Ram Ltd.speciali
seinthemanuf actureofnov eltr
ansistors.Theyhav erecentl
ydev el
oped
technologytodesignanewr adi
ot r
ansistorcapableofbei ngusedasanemer gencylamp
also.Theyarequiteconfidentofsell
ingall t
he8,000unitst hattheywouldbemaki ngina
year.Thecapit
al equi
pmentt hatwoul dber equir
edwi l
lcost` 25lakhs.I
twillhavean
economi cli
feof4y earsandnosi gnifi
cantterminalsalvagev al
ue.
Duringeachoft hefir
stfouryearspromot ionalexpensesar eplannedasunder

Year 1 2 3 4 Vari
ablecost
ofproduct
ion
Adv
ert
isement 1000000 75000 60000 30000 andsell
ing
expensesp.u.
Ot
her
s 50000 75000 90000 120000 Rs.250.
Addi
ti
onal
fi
xedoper at
ingcostsincurr
edbecauseoft hisnewpr oductarebudgetedat` 75,
000peryear
.The
company ‘sprof
itgoalscallf
oradiscountedr ateofreturnof15%aftertaxesoni nvest
mentsonnew
products.Theincomet axrateonanav eragewor ksoutt o40%.Youcanassumet hatt
hestr
aightli
ne
methodofdepr eciat
ionwillbeusedfortaxandr eport
ing.Workoutani ni
ti
al sel
l
ingpri
ceperunitof
theproductthatmaybef i
xedforobtai
ningt hedesiredrateofret
urnoni nvestment.
Presentv
alueofannui
tyof`
1recei
vedorpai
dinast
eadyst
ream t
hroughout4y
ear
sint
he
fut
ureat15%is3.007
Ans.

Chapt
er-
|Capi
tal
Budget
ing 16
FI
NANCI ALMANAGEMENT D.K.BI
SWAS[ M.COM.ACMA(
AICWA)
]
Capi
talBudget
ing (9831410262)

STUDENTS’
NOTE

Chapt
er-
|Capi
tal
Budget
ing 17