Investment Rs 10,00,000 minimum expected rate of return = 12%

Life of the project 8 years Minimum pay back period 4.5 years

1. Annual cashflows Rs 2,50,000

Payback period= initial outlay / annual cashflows

= 10,00,000/2,50,000 = 4 years

Accept the project as the payback period is less than the minimum payback period

2. Annual cashflows are Rs 2,00,000 per annum

Payback period = 10,00,000 / 2,00,000 = 5 years
Reject the project because the payback period is more than the minimum payback period

3. Annual cashflows are as follows:

Year Cashflows Cumulative cashflows

1 4,00,000 4,00,000
2 3,00,000 7,00,000
3 2,00,000 9,00,000
4 4,00,000 13,00,000
5 3,50,000 16,50,000
6 2,50,000 19,00,000
7 2,00,000 21,00,000
8 3,00,000 24,00,000

Payback period = 3 years + [(1,00,000/4,00,000)x12]

= 3 years 3months

ACCOUNTING RATE OF RETURN:

AVERAGE ANNUAL PROFITS x 100

NET INVESTMENT

Firms expected rate of return is 22%

Option 1:

Investment Rs 10,00,000

Annual profits (cashflows) Rs 2,50,000 every year for 8 years

Average annual profits = Rs 2,50,000 (2,50,000 + 2,50,000…../8)

ARR = (average annual profits / net investment ) X 100

= (2,50,000 / 10,00,000) X 100 = 25%

Accept as ARR is greater than the firms minimum rate of return

Option – 2

Investment Rs 10,00,000
Average profits = Rs 2,00,000 per annum for 8 years

ARR = (2,00,000/10,00,000) X 100 = 20%

Reject as the ARR is less than the expected rate of return

Option -3

Investment Rs 10,00,000

Average profits = total profit / number of years

= (4,00,000+ 3,00,000+2,00,000+4,00,000+3,50,000+2,50,000+2,00,000+3,00,000)/8

=24,00,000 /8 = Rs 3,00,000

ARR

= (average profits/ net investment) X100

= (3,00,000/10,00,000)x100

=30%

Accept as ARR is greater than the expected rate of return.

NET PRESENT VALUE:

Option 1:
Investment Rs 10,00,000
Minimum expected rate of return 12%
Annual cash flows Rs 2,50,000 for 8 years
Present value of annuity (12%, 8 years) = 4.9676
Present value of cash inflows = annual cash flows X annuity factor
= 2,50,000 x 4.9676
= Rs 12,41,900
Present value of cash outlfows = cashoutflow X annuity factor
= Rs 10,00,000 X 1 = Rs 10,00,000
Net present value = present value of cash inflows – present value of cash outflows
= Rs 12,41,900 – 10,00,000
= Rs 2,41,900
Accept the investment proposal as it is having a positive NPV.

Option 2:
Investment Rs 10,00,000
Minimum expected rate of return 12%
Annual cash flows Rs 2,00,000 for 8 years
Present value of annuity (12%, 8 years) = 4.9676
Present value of cash inflows = annual cash flows X annuity factor
= 2,00,000 x 4.9676
= Rs 9,93,520

Present value of cash outlfows = cashoutflow X annuity factor

= Rs 10,00,000 X 1 = Rs 10,00,000
Net present value = present value of cash inflows – present value of cash outflows
= Rs 9,93,520 – 10,00,000
= (Rs 6,480)
Reject the investment proposal as there is negative NPV
Option 3:
Investment Rs 10,00,000
Minimum expected rate of return 12%
Annual cash flows are as follows:

1 2 3 4= 2x3
Year Cash flows PV Factor (12%) Present value of
cash inflows
1 4,00,000 0.89286 3,57,144
2 3,00,000 0.797189 2,59,156
3 2,00,000 0.71178 1,42,356
4 4,00,000 0.63552 2,54,208
5 3,50,000 0.56743 1,98,600
6 2,50,000 0.50663 1,26,657
7 2,00,000 0.45305 90,610
8 3,00,000 0.40383 1,21,149
Total present value of cash in flows 15, 49,880

Net present value = present value of cash inflows – present value of cash outflows
= 15,49,880 – 10,00,000
= Rs 5, 49 880
Accept the proposal as there NPV is positive.

PROFITABILITY INDEX:

Present value of cash inflows

Present value of cash outflows

Option 1 = 12,41,900/ 10,00,000 = 1.2419

Option 2 = 9, 93,600 /10,00,00 = 0.9936
Option 3 = 15,49,880 / 10,00,000= 1.54988

Option 1 and option 3 should be accepted as the PI is greater than 1 and option 2 should be rejected as the PI is less than1.

INTERNAL RATE RETURN:

IRR is that rate:

Present value of cash inflows = present value of cash outflows

Option 1:
Investment Rs 10,00,000
Annual cash flows Rs 2,50,000 for 8 years
Life of the project = 8 years

Present value factor = initial outlay /annual cash flow

= 10,00,000 / 2,50,000
=4
The IRR is 12% approx.

Option 2:
Investment Rs 10,00,000
Annual cash flows Rs 2,00,000 for 8 years
Life of the project = 8 years
Present value factor = initial outlay / annual cash flow
= 10,00,000 / 2,00,000
=5
Refer table c – 8 years find where 5 lies
At 9% PV factor is 0.50187
IRR = 9%

Option 3:
Investment Rs 10,00,000
Minimum expected rate of return 12%
Annual cash flows are as follows:

1 2 3 4= 2x3 5 6=2x5 6 7= 2x6 8 9= 2x8

Year Cash flows PV factor Present PV Present PV factor Present PV factor Present
at 22% value of factor at value of at 25% value of at 30% value of
cash 24% cash cash cash
inflows inflows inflows inflows
1 4,00,000 0.81969 3,27,876 0.80645 3,22,580 0.80000 3,20,000 0.76933 3,07,732
2 3,00,000 0.67186 2,01,558 0.66036 1,98,108 0.64000 1,92,000 0.59172 1,77,516
3 2,00,000 0.55071 1,10142 0.52449 1,04,898 0.51200 1,02,400 0.45517 91,034
4 4,00,000 0.45140 1,80,560 0.42297 1,69,188 0.40960 1,63,840 0.35013 1,40,052
5 3,50,000 0.37000 1,29,500 0.34111 1,19,388 0.32768 1,14,688 0.26933 94,265
6 2,50,000 0.30328 75,820 0.27509 68,772 0.26214 65,535 0.20718 51,795
7 2,00,000 0.24859 49,718 0.22184 44,368 0.20972 41,944 0.15897 31,794
8 3,00,000 0.20376 61,128 0.17891 53,673 0.16777 50,331 0.12259 36,777
10,80,976 10,50,738 9,30,965

IRR = present value of cash inflows = present value of cash outflows

= 15,49,880 – 10,00,000
= Rs 5, 49 880
total present value of cash inflows at 25% = Rs 10, 50,738 i.e it is 50,738 more than Rs 10,00,000
Total present value of cash inflows at 30% = Rs 9,30,965 ie. it is less than 69,035 less than Rs 10,00,000

internal rate of return = 25 + ( 50,738 ) x (30-25)

(50,738+69035)

= 25+ 2.1180
= 27.1180%