Questions on Capital Budgeting

Prof. Prapti Paul

• Question 1: machine A costs Rs.1,00,000 payable immediately. Machine B costs
Rs.1,20,000 half payable immediately and half payable in one year’s time. The cash
receipts expected are as follows:
Year Machine A Machine B
1 20,000 -
2 60,000 60,000
3 40,000 60,000
4 30,000 80,000
5 20,000 -
At 7% opportunity cost, which machine should be selected on the basis of NPV?

ANSWER: NPV Machine A = Rs. 40,870 ; NPV Machine B = Rs. 46,280. Machine B will be
selected.
• Question 2: a co. is considering a new project for which the investment data is:
➢ Capital outlay Rs.2,00,000
➢ Depreciation 20% p.a
Forecasted annual income before charging depreciation, but after all other charges are as
follows:
Year 1 Rs. 1,00,000
Year 2 1,00,000
Year 3 80,000
Year 4 80,000
Year 5 40,000
4,00,000
On the basis of the available data, set out calculations, illustrating and comparing the
following methods of evaluating the return:
a) Payback method
b) Rate of return on original investment

ANSWER: Payback period is 2 years. Rate of return = (40,000/2,00,000) *100 = 20%

• Question 3: a co. has to consider the following project :
Cost Rs.10,000
Cash Inflows:
Year 1: Rs.1,000
Year 2: 1,000
Year 3: 2,000
Year 4: 10,000
Compute the internal rate of return and comment on the project if the opportunity cost is
14%.

ANSWER: Approx payback = 10,000/3500 = 2.857

From the PVAF Table value near to 2.857 for 4 years is found in 15%. However as cash flows
in the earlier years are lower hence NPV be found at 10% and 11%.
NPV at 10% = 67 and NPC at 11% = -235
Interpolation between 10% and 11% IRR = 10.22%