Financial Management

Assignment

Capital Budgeting
Ques: A company has to select one of the following two projects:

Project A Project B
Cost 22,000 20,0000
Cash Inflows:
Year1 12,000 2,000
Year 2 4,000 2,000
Year 3 2,000 4,000
Year 4 10,000 20,000

Using the Internal Rate of Return methods suggest which Preferable is.

Solution:

F = Cash outlay /Cash inflow

Project A

Cash Inflow = Total cash inflow / No. of years

= 28,000 /4 = 7000

= 22000 /7000 = 3.14

The factor thus calculated will be located in table II below. This would give the estimated
rate of return to be applied discounting the cash for the internal rate of returns. In this of
project A the rate comes to 10% while in case of project B it comes to15%.

Project A

Year Cash Inflows(Rs.) Discounting Present Value(Rs.)

Factor@ 10%
1 12,000 0.909 10908
2 4,000 0.826 3304
3 2,000 0.751 1502
4 10,000 0.683 6830
Total 22544
Less: Initial 20,000
investment
Net Present Value 544

The present value at 10% comes to Rs. 22,544. The initial investment is Rs. 22,000. Interest
rate of return may be taken approximately at 10%.

Name: Vishal Chandak

MBA 2nd Semester
 Financial Management

In the case more exactness is required another trial which is slightly higher than 10%(since at
this rate the present value is more than initial investment) may be taken. Taking a rate of 12%
the following results would emerge.

Year Cash Inflows(Rs.) Discounting Present Value(Rs.)

Factor@ 12.6%
1 12,000 0.893 10,716
2 4,000 0.794 3,188
3 2,000 0.712 1,424
4 10,000 0.636 6360
Total 21,688
Less: Initial 22,000
investment
Net Present Value (-) 312

IRR=Base factor + Positive net present value/Difference in positive and Negative net
present value *DP

 Base factor= 10%

 DP = 2%

10%+544/544-(-312)*2%

10%+544/856*2

10%+1.27

=11.27%

Name: Vishal Chandak

MBA 2nd Semester
 Financial Management

Project B

Year Cash Inflows(Rs.) Discounting Present Value(Rs.)

Factor@ 15%
1 2,000 0.909# 1,818
2 2,000 0.826 1,652
3 4,000 0.751 3,004
4 20,000 0.683 13,660
Total 20,134
Less: Initial 20,000
investment
Net Present Value 134

IRR= 10%+134/134-(2676)*5*

=10%+0.24 IRR = 10.24%

Thus, internal rate of return in project ‘A’ is higher as compared to project ‘B’. Therefore
project ‘A’ is preferable.

Name: Vishal Chandak

MBA 2nd Semester