Practice Question for Capital Budgeting

1. The cash flows of two mutually exclusive projects are as under:

Project P Project Q
Year Cash Flow (Rs.) Year Cash Flow (Rs.)
0 (40000) 0 (20000)
1 13,000 1 7,000
2 8,000 2 13,000
3 14,000 3 12,000
4 12,000 4 -
5 11,000 5 -
6 15,000 6 -

Required:
 Estimate the net present value (NPV) of the Project ‘P’ and ‘Q’ using 15% as the
hurdle rate.
 Estimate the internal rate of return (IRR) of the Project ‘P’ and ‘Q’.
 Why there is a conflict in the project choice by using NPV and IRR criterion?

Ans: NPV (P) Rs. 5381, NPV (Q) Rs. 3814

IRR (P) 19.75% IRR (Q) 25.20%

2. The initial cash outlay of a project is RS. 1,00,000 and it can generate cash inflow of
Rs. 40,000, Rs. 30,000, Rs. 50,000 and Rs. 20,000 in year 1 through 4. Assume a 10%
rate of discount, calculate the NPV and profitability index.

Ans.: NPV= Rs. 12,383.03, PI = 1.12383

3. A manager is trying to decide which of two mutually exclusive projects to undertake.

The manager has constructed the following table showing cash flow:-
 
Project/ Year 1 2 3
I 80000 -35,000 110,000
II 100,000 90,000 105,000
The salvage value is Rs. 10,000 in each case. Which project should be
undertaken if the cost of capital is 10% and the cash outflow in each case is Rs. 1,
00,000, using NVP as the decision criterion?

Ans.: NPV (A) Rs. 33,930, NPV (B): Rs. 1,51,605

 4. A project requires investment of Rs. 50,00,000 and will generate following cash
inflows (after-tax)
1 12,50,000
2 11,50,000
3 10,00,000
4 12,00,000
5 12,00,000
6 10,60,000
Calculate the IRR of the project and NPV at 12%.

Ans. : IRR = 10%, NPV = -2,74,812.45

5. Considering target pay-back period as 3 years, the cash flow of the two proposals are
as follows:-

Particulars Proposal A Proposal B

Investment Rs. 10,000 Rs. 10,000
Net cash benefits
Year 1 Rs. 5,000 Rs. 3,200
Year 2 Rs. 4,800 Rs. 3,000
Year 3 Rs. 3,000 Rs. 3,000
Year 4 - Rs. 2,500
Year 5 - Rs. 2,000

Which project will be accepted using pay-back period as the evaluation criteria?

(Project A 2.066 years, B 3.32 years, Project A will be selected as it has PBP
shorter than Target PBP of 3 yrs.)

6. Shiva fish farm is willing to buy a new fish-flaking facility which will cost Rs. 1, 00,000.
The expected life of the facility is 4 years. Calculate the payback period if the expected net
cash flows are as follows:

Year 1 Rs. 34,432

Year 2 Rs. 39,530
Year 3 Rs. 39,359
Year 4 Rs. 32,219

You are also required to show NPV of the project if the cost of capital is 12%.

(Ans: PBP = 2.66 years, NPV = Rs. 10,746.65)

7. A project, costing Rs. 30,000, has the following cash flow:-

Year Amount (Rs.)

1 -2000
2 24000
 3 -7000
4 29000

The discount rate is 10%. Find out the NPV. Do you think that IRR would be suitable
evaluation technique in this respect? Why or why not ?

(Ans. : NPV = Rs. 2,546.72, IRR= 12.95%)

8. XYZ Ltd. Provides you the following information:-

Purchase price of the machine Rs. 9, 00,000
Useful life of machine 5 years
Estimated salvage value Rs. 1, 00,000
Cash inflow Rs. 2,40,000
The cost of capital for the firm is 10%. Calculate NPV of the machine and advice.

(Ans.: NPV= Rs. 71,700)

9. Diaz Microfilm Inc. is comparing two processes for its plant. Each process would have an
expected useful life of ten years. The initial investment and annual cash return from each
process are shown below:-
Analyze the above problem using the net present value methods. Perform the analysis using
12% cost of capital

  Process A Process B
Initial Investment Rs. 2,00,000 Rs.3,00,000
Annual Cash flow Rs. 35,000 Rs. 60,000
for years 1
through 10

Ans: NPV (A)= -2242, NPV (B)=39013

10. Nice Rice mills wants to install a machinery which will cost Rs. 2,50,000. The expected cash
flows are as follows:-
• Year 1 Rs. 65,000
• Year 2 Rs. 1,00,000
• Year 3 Rs. 75,000
• Year 4 Rs. 80,000
Find IRR of the machine. If the K o of the firm is 12%. Should the Nice Rice mill invest in this
machine? Why or why not?

Ans. IRR= 10.49%, should not as IRR < Ko