Chapt

er

Capi
talbudget
ing
(
II
)DI
SCOUNTEDTECHNI
QUESOFCAPI
TALBUDGETI
NG:

1)NETPRESENTVALUE(
NPV)
:

NPV=PVCI
F-COF

PVCI
F=Pr
esentv
alueofcashi
nfl
ow

COF=Cashout
fl
ow/
Out
lay
/Costoft
hepr
oject
/Ini
ti
ali
nvest
ment

2)PROFI
TABI
LITYI
NDEX(
PI)ORBENEFI
TCOSTRATI
O(BCR)
l

PI=PVCI
F/COF

From thef
oll
owingi
nfor
mati
onofmachi
nesarerequi
redt
ocal
cul
ateNPVandPr
ofi
tabi
l
ity
i
ndex.advi
sethemanagementwi
l
lbemorepr
ofit
able.

Par
ti
cul
ars Machi
neA Machi
neB

I
nit
ial
out
lay 32,
000 25,
000

Netcashf
lowsp.
a 15,
000 10,
000

Est
imat
edl
i
fe 3y
ear
s 3Year
s

Costofcapi
tal 10% 10%

sol
uti
on:

Machi
neA

Year CI
F PV@10% PVCI
F

1 15,
000 0.
909 13,
635

2 15,
000 0.
826 12,
390

3 15,
000 0.
751 11,
265

37,
290
NPV=PVCI
F-COF

=37,
290-32,
000

=Rs.
5290

PI=PVCIF/COF
37,
290/32,
000
=1.17

Machi
ner
yB

Year CI
F PV@10% PVCI
F

1 10,
000 0.
909 9,
090

2 10,
000 0826 8,
260

3 10,
000 0.
751 7,
510

24,
860
Suggest
ions:Machi
ner
yAshoul
dbesuggestedbecauset
her
eNPVi
shi
ghesti
.e.
5290.and
moreprofi
tabl
eascompar
edtotheot
herone.

Q.
no.
2From thefoll
owinginf
ormat
ionoft
womachinesarer
equiredtocal
cul
ateNPVand
Pr
ofi
tabi
l
ityi
ndex.advi
sethemanagementwhi
chofthetwoalt
ernati
veswil
lbemorepr
ofi
tabl
e.

Par
ti
cul
ars Machi
neA Machi
neB

I
nit
ial
out
lay 50,
000 60,
000

Netcashf
lowsp.
a 20,
000 30,
000

Est
imat
edl
i
fe 5y
ear
s 5y
ear
s

Costofcapi
tal 10% 10%

Sol
uti
on:

Year PVfact
or A PVfact
or B
@ 10% @ 10%
CI
F PVCI
F CI
F PVCI
F

1 0.
909 20,
000 18,
180 0.
909 30,
000 27,
270

2 0.
826 20,
000 16,
520 0.
826 30,
000 24,
780

3 0.
751 20,
000 15,
020 0.
751 30,
000 22,
530

4 0.
683 20,
000 13,
660 0.
683 30,
000 20,
490

5 0.
621 20,
000 12,
440 0.
621 30,
000 18,
600

TOTAL -
- -
- 75,
780 -
- 1,
13,
670

NPV(Machi
ner
yA)=PVCI
F-COF=75,
780-50,
000=25,
780

NPV(Machi
ner
yB)=PVCI
F-COF=1,
13,
670-60,
000=53,
670

PI(machi
ner
yA)=PVCI
F/COF=75,
780/50,
000=1.
52

PI(machi
ner
yB)=PVCI
F/COF=1,
13,
670/
60,
000=1.
89

suggest
ions:Machi
ner
yBshoul
dbesuggest
ed.
Q.no.3From t
hef
oll
owingdetail
sofcashf
lowsfortwoal
ter
nat
ivesr
elat
ingtoaproj
ect
;
Calculat
eNPVandPr ofi
tabi
l
ityi
ndexandwhichyouwoul
dchoosealt
ernati
vesandwhy?

Year Tat
a(Rs.
) Bat
a(Rs.
)

0 (
2,00,
000) (
2,10,
000)

1 50,
000 80,
000

2 80,
000 60,
000

3 1,
00,
000 80,
000

4 80,
000 60,
000

5 60,
000 80,
000

Costofcapi
tal 15% 15%

Sol
uti
on:

Year PVfact
or TATA BATA
@15%
CI
F PVCI
F CI
F PVCI
F

1 0.
870 50,
000 43,
500 80,
000 69,
600

2 0.
756 80,
000 60,
480 60,
000 45,
360

3 0.
658 1,
00,
000 65,
800 80,
000 52,
640

4 0.
572 80,
000 45,
760 60,
000 34,
320

5 0.
497 60,
000 29,
820 80,
000 39,
760

Tot
al Tot
alPVCI
F 2,
45,
360 Tot
alPVCI
F 2,
41,
680

(
-)COF 2,
00,
000 COF 2,
10,
0000

NPV 45,
360 NPV 31,
680
Pr
ofi
tabi
l
ityi
ndex(TATA)=PVCI
F/COF=2,
45,
310/2,
00,
000=1.
22

Pr
ofi
tabi
l
ityi
ndex(BATA)=PVCI
F/COF=2,
41,
600/2,
10,
000=1.
15

Suggest
ions:TATAcoshoul
dbesuggest
ed.

Q.no4From t
hefol
l
owingdetail
sofAft
ercashinf
lowsf
oralter
nati
vesrelat
ingtoapr
oject
;
Calcul
ateNPVandProfi
tabi
l
ityi
ndexandwhichyouwouldchoosealt
ernati
vesandwhy?

I
nit
ial
out
layRs.2,
00,
000

Costofcapi
tal
is10%.

Year Pr
ojectX(
Rs.
) Pr
ojectY(
Rs.
)

1 35,
000 1,
18,
000

2 80,
000 60,
000

3 90,
000 40,
000

4 75,
000 14,
000

5 20,
000 13,
000

sol
uti
on:

Year PVf
actor X Y
@10%
Netcash PVcash Netcash PVcash
fl
ows f
lows fl
ows f
lows

1 0.
909 35,
000 31,
815 1,
18,
000 1,
07,
262

2 0.
826 80,
000 66,
080 60,
000 49,
560

3 0.
751 90,
000 67,
590 40,
000 30,
040

4 0.
683 75,
000 51,
225 14,
000 9,
562

5 0.
620 20,
000 12,
400 13,
000 8,
060
Tot
al PVCI
F 2,
29,
110 PVCI
F 2,
04,
484

(
-)
COF 2,
00,
000 (
-)
COF 2,
00,
000

NPV 29,
110 NPV 4,
484

PI
(X)=PVCI
F/COF=2,
29,
110/
2,00,
000=1.
15

PI
(Y)=PVCI
F/COF=2,
04,
484/
2,00,
000=1.
02

Suggest
ions:
Proj
ectxshoul
dbesuggest
ed.

Q.
no5From t
hefoll
owingdet
ail
sofAftercashi
nfl
ows(i
.e.af
tertaxandbef
oredepr
eci
ati
on)f
or
al
ter
nat
ivesr
elat
ingtoaproj
ect
;Calculat
eNPVandProf
itabil
it
yindex.

I
nit
ial
out
lay20,
000

Year Netcashf
lows(
Rs.
)

1t
o5 7,
000p.
a

6 8,
000

7 10,
000

8 15,
000

9 10,
000

10 4,
000

Usi
ng10%ast
hecostofcapi
tal
(rat
eofdi
scount
).

Ans:
NPV=Rs.
28,
961

PI=2.
45
Q.no6Speedagecompanyl td.i
sconsi
deri
ngtheprojectRs.5,
00,000.
Theest i
matedsal
vage
valuei
szero.Taxrateis55%.Thecompanyusesstraightl
inemet hodfordepreci
ati
onandt
he
proposedprojecthascashinfl
owbefor
edepreci
ati
onandt ax(CFBDT)asf ol
lows:

Year CFBDT(
Rs.
)

1 1,
50,
000

2 2,
50,
000

3 2,
50,
000

4 2,
00,
000

5 1,
50,
000

Ifthecostofcapi
tal
is12%( r
ateofdiscount
),woul
dyour
ecommendt
heaccept
anceoft
he
proj
ectunderNPVandPr of
it
abil
it
yindex?

Sol
uti
on:

Year EBDT (
-)Dep EBT (
-)Tax EAT (
+)Dep cash PV@12% PVCI
F
@55% i
nflow

1 1,
50,
000 1,
00,
000 50,
000 27,
500 22,
500 1,
00,
000 1,
22,
500 0.
893 1,
09,
392.
5

2 2,
50,
000 1,
00,
000 1,
50,
000 82,
500 67,
500 1,
00,
000 1,
67,
500 0.
797 1,
33,
497.
5

3 2,
50,
000 1,
00,
000 1,
50,
000 82,
500 67,
500 1,
00000 1,
67,
500 0.
712 1,
19,
260

4 2,
00,
000 1,
00,
000 1,
00,
000 55,
000 45,
000 1,
00,
000 1,
45,
000 0.
636 92,
220

5 1,
50,
000 1,
00,
000 50,
000 27,
500 22,
500 1,
00,
000 1,
22,
500 0.
567 69,
457.
5

5,
23,
827.
5

Depr
eci
ati
on=Costofpr
oject/no.
ofy
ear
s. =5,
00,
000/5=1,
00,
000
NPV=PVCI
F-COF

5,
23,
827.
5-5,
00,
000=23,
827.
5

PI=PVCI
F/COF

5,
23,
827.
5/5,
00,
000=1.
05

Q.
no7SPcompanyl
td.
isconsider
ingt hepr
ojectRs.3,
00,000.Taxrateis55%andt hepr oposed
Year EBDT( Rs.) proj
ecthascashi nfl
owbef oredepr eci
ationand
tax(CFBDT)asf oll
ows:
1 2,
50,000
Ifthecostofcapitalis15%( r
ateofdi scount),
2 350,000 wouldyour ecommendt heacceptanceoft he
proj
ectunderNPVandPr of
it
abil
it
yi ndex?
3 3,
50,000

4 3,
00,
000

5 2,
50,
000

SOLUTI
ON:

NPV=2,
64,
362

PI=1.
88

Ye EBDT (
-)dep EBT (-
) EAT (+) CI
F Pv@1 PVCI
F
ar Tax@55 dep 5%
%

1 2,
50,
00 60,
000 1,
90,
00 1,
04,
500 85,
500 60,
00 1,
45,
500 0.
870 1,
26,
585
 0 0 0

2 3,
50,
00 60,
000 2,
90,
00 1,
59,
500 1,
30,
50 60,
00 190,
500 0.
756 1,
44,
018
0 0 0 0

3 3,
50,
00 60,
000 2,
90,
00 1,
59,
500 1,
30,
50 60,
00 1,
90,
500 0.
658 1,
25,
349
0 0 0 0

4 3,
00,
00 60,
000 2,
40,
00 1,
32,
000 1,
08,
00 60,
00 1,
68,
000 0.
572 96,
096
0 0 0 0

5 2,
50,
00 60,
000 1,
90,
00 1,
04,
500 85,
500 60,
00 1,
45,
500 0.
497 72,
314
0 0 0

PVCI
F 5,
64,
362

(
-)COF 3,
00,
000

NPV 2,
64,
362

(
II
I)Discount
edpay
backper
iod=No.
ofy
ear
s+(
Requi
redAmt/
PVCI
Foft
henexty
ear
)*12
months.

Requi
redamount=Costofpr
oject-cummul
ati
vePVCI
F
Q.
no9Acompanyl
td.
ispl
anni
ngani
nvest
mentpr
oject
..Ther
ateofdi
scounti
s10%.
cal
cul
ate:

I
)Paybackper
iodandARR
I
I)Di
scount
edpaybackper
iod

I
II
)NPV

I
V)Pr
ofi
tabi
l
ityi
ndex

Par
ti
cul
ars P Q

Costofi
nvest
ment 2,
00,
000 2,
80,
000

Expect
edl
i
fe 5y
ear
s 5y
ear
s

Proj
ectedneti
ncome(af t
er
depreci
ati
on,
int
erestand
t
axes) Rs. Rs.

Year

1 10,
000 24,
000

2 10,
000 24,
000

3 20,
000 24,
000

4 20,
000 24,
000

5 20,
000 24,
000
Sol
uti
on:

Pr
ojectP

I
)Pay
backper
iodandARR

Year EAT (
+)Depr
eci
ati
on cashi
nfl
ow cummulat
ive
cashi
nfl
ow

1 10,
000 40,
000 50,
000 50,
0000

2 10,
000 40,
000 50,
000 1,
00,
000

3 20,
000 40,
000 60,
000 1,
60,
000

4 20,
000 40,
000 60,
000 2,
20,
000

5 20,
000 40,
000 60,
000 2,
80,
000

t
otal 80,
000

Depr
eci
ati
on=costofpr
oject/no.
ofy
ear
s

2,
00,
000/
5=40,
000

Pay
backper
iod=no.
ofy
ear
s+(r
equi
redamt/cashi
nfl
owofnexty
ear)*
12mont
hs

3y
ear
s+(
40,
000/60,
000)*
12mont
hs=3y
ear
s8mont
hs

ARR=(Av
g.NPAT/i
nit
iali
nvest
ment
)*100=(
16,
000/
2,00,
000)
*100=8%
or0.
08

Av
g.NPAT=Tot
alPAT/No.ofy
rs

80,
000/5=16,
000
I
I)Di
scount
edpay
backper
iod

y
ear EAT (
+)Dep cashi
nfl
ow PV@10% PVCI
F cummul
ati
ve
PVCI
F

1 10,
000 40,
000 50,
000 0.
909 45,
450 45,
450

2 10,
000 40,
000 50,
000 0.
826 41,
300 86,
750

3 20,
000 40,
000 60,
000 0.
751 45,
060 1,
31,
810

4 20,
000 40,
000 60,
000 0.
683 40,
980 1,
72,
790

5 20,
000 40,
000 60,
000 0.
621 37,
260 2,
10,
050

2,
10,
050

Di
scountedPay
backper
iod=no.
ofy
ear
s+(r
equi
redamt/PVCI
Fofnexty
ear)*
12
months

=4y
ear
s+(
27,
210/37,
260)*
12mont
hs

=4y
ear
s+8.
76mont
hs

=4y
ear
s9mont
hs

I
II
)Discount
edpaybackPr
ofi
tabi
li
ty(
NPV)=PVCI
F-COF
=2,10,
050-2,00,
000=Rs.
10,
050

I
V)Pr
ofi
tabi
li
tyi
ndex=PVCI
F/COF

=2,
10,
050/2,
00,
000=1.
04
I
nter
nalr
ateofr
etur
n:

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)

1)
Cashout
layi
sRs.
80,
000I
n2019CI
FisRs.1,
00,
000,
PVFact
or10%and20%Cal
cul
ateI
RR?

Answer
:

=10%=100/
110=0.
909

I
n2020=20%=0.
833

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)

2)Cashout
layi
sRs20,
000,CI
FisRs.35,
000,PVFact
or10%and20%Cal
cul
ateI
RR?
PV=10%=0.
909

PVCI
FD1=35,
000*
0.909=31,
815

PV=20%=0.
833

PVCI
FD2=35,
000*
0.833=29,
155

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)
=

3)Cashout
layi
sRs50,
000,CI
FisRs.80,
000,PVFact
or15%and20%Cal
cul
ateI
RR?

Sol
uti
on:
Q.no10From thef
oll
owingdetai
l
sofAf
tercashinf
lowsforal
ter
nat
ivesr
elat
ingt
oapr oj
ect
;
Calcul
ateNPV, Pr
ofi
tabi
li
tyi
ndexwi
th10%PVf actorandI
RRandwhichyouwouldchoose
al
ternat
ivesandwhy?
I
nit
ial
out
layRs.2,
00,
000

Costofcapi
tal
is10% and20%

Year Pr
ojectX(
Rs.
) Pr
ojectY(
Rs.
)

1 35,
000 1,
18,
000

2 80,
000 60,
000

3 90,
000 40,
000

4 75,
000 14,
000

5 20,
000 13,
000

sol
uti
on:

Pr
ojectX

y
ear CI
F PV@10% PVCI
F PV@20% PVCI
F

(
D1) D1 (
D2) D2

1 35,
000 0.
909 31,
815 0.
833 29,
155

2 80,
000 0.
826 66,
080 0.
694 55,
520

3 90,
000 0.
751 67,
590 0.
579 52,
110

4 75,
000 0.
683 51,
225 0.
482 36,
150

5 20,
000 0.
621 12,
420 0.
402 8,
040

Tot
alPVCI
F 2,
29,
130 PVCI
F 1,
80,
975

(
-)COF 2,
00,
000 (
-)COF 2,
00,
000

NPV 29,
130 NPV (
19,
025)

PI=PVCI
F/COF 1.
15 0.
90

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)

=
Pr
ojectY

y
ear CI
F PV@10% PVCI
FD1 PV@20% PVCI
FD2

D1 D2
1 1,
18,
000 0.
909 1,
07,
262 0.
833 98,
294

2 60,
000 0.
826 49,
560 0.
694 41,
640

3 40,
000 0.
751 30,
040 0.
579 23,
160

4 14,
000 0.
683 9,
562 0.
482 6,
748

5 13,
000 0.
621 8,
073 0.
402 5,
226

Tot
alPVCI
F 2,
04,
497 1,
75,
068

(
-)COF 2,
00,
000 2,
00,
000

NPV 4,
497 (
24,
932)

PI=PVCI
F/COF 1.
022 0.
875

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)
Suggest
ions:Pr
ojectXi
smor
epr
ofi
tabl
ebecauset
her
eIRRi
shi
gheri
.e16.
05%t
hanPr
oject
Yi.
e11.528%.

Q.no11From thef
oll
owingdetai
l
sofAf
tercashinf
lowsforal
ter
nat
ivesr
elat
ingt
oapr oj
ect
;
Calcul
ateNPV, Pr
ofi
tabi
li
tyi
ndexwi
th10%PVf actorandI
RRandwhichyouwouldchoose
al
ternat
ivesandwhy?

Costofcapi
tal
forI
RRi
s15% and20%

Par
ti
cul
ars P Q

Costofi
nvest
ment 40,
000 50,
000

Expect
edl
i
fe 5y
ear
s 5y
ear
s

Proj
ectednetincome(af t
er
depreci
ation,
int
erestand
taxes)EAT Rs. Rs.

Year

1 10,
000 24,
000

2 10,
000 24,
000

3 20,
000 24,
000

4 20,
000 24,
000

5 20,
000 24,
000

Sol
uti
on:
Proj
ectP

Year EAT (
+)Dep. Cashi
nfl
ow Pv
@10% PVCI
F

1 10,
000 8,
000 18,
000 0.
909 16,
362

2 10,
000 8,
000 18,
000 0.
826 14,
868

3 20,
000 8,
000 28,
000 0.
751 21,
028

4 20,
000 8,
000 28,
000 0.
683 19,
124

5 20,
000 8,
000 28,
000 0.
621 17,
388
 PVCI
F 88,
770

(
-)
COF 40,
000

NPV 48,
770

PI
= 88,
770/
40,
000=
PVCI
F/COF 2.
22

Depr
eci
ati
on=CostofPr
oject
/no.
ofy
ear
s

=40,
000/
5=8,
000

I
RR:

Year Cashi
nfl
ow PV@15% PVCI
FD1 PV@20% PVCI
FD2

D1 D2

1 18,
000 0.
870 15,
660 0.
833 14,
994

2 18,
000 0.
756 13,
608 0.
694 12,
492

3 28,
000 0.
658 18,
424 0.
579 16,
212

4 28,
000 0.
572 16,
016 0.
482 13,
496

5 28,
000 0.
497 13,
916 0.
402 11,
256

77624 68,
450

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)

=15%+(
77,
624-
40,
000)/(
77,
624-68,
450)*
(20%-
15%)

=15%+(
37,
624/
9,174)*
5%

=15%+(
4.101*
5%)

=15%+0.
205

=15.
205%

Pr
ojectQ(Homewor
k)
Q.no.
12(Homewor k)From thefol
lowingdetai
l
sofcashf l
owsfort
woalt
ernati
vesrel
ati
ngt
oa
proj
ect;Cal
cul
ateNPV , Pr
ofit
abil
ityi
ndexandDi scount
edpaybackper
iodby20%andwhi ch
youwouldchoosealt
ernati
vesandwhy ?cal
cul
ateIRRWiththef
oll
owi
nginfor
mation:

Year Cockt
ail
(Rs.
) Mockt
ail
(Rs.
)

0 (
2,00,
000) (
2,10,
000)

1 50,
000 80,
000

2 80,
000 60,
000

3 1,
00,
000 80,
000

4 80,
000 60,
000

5 60,
000 80,
000

Costofcapi
tal 10%&15% 15%&20%

ANS10.
1183=10.
12% I
RR=10.
13% I
RR=15.
08%

NPV=Rs.17,
750 NPV=Rs.5,
680
PI
=1.089 PI
=1.027
DI
SC.Payback=4y
ear
s DI
SC.Payback=4y
ear
s10
3months months

Sol
uti
on:

Cockt
ail
(Rs.
)

Year CI
F PV@10% PVCI
FD1 PV@15% PVCI
FD2
D1 D2

1 50,
000 0.
909 45,
450 0.
870 43,
500

2 80,
000 0.
826 66,
080 0.
756 60,
480
3 1,
00,
000 0.
751 75,
100 0.
658 65,
800

4 80,
000 0.
683 54,
640 0.
572 45,
760

5 60,
000 0.
621 37,
260 0.
497 29,
820

2,
78,
530 2,
45,
360

I
RR=D1+(PVCI
FD1-COF)/(
PVCI
FD1-PVCI
FD2)*
(D2-
D1)

Q.
no.13(Homewor k)Fr
om thefol
lowi
ngdetai
l
sofcashf l
owsf
ortwoalt
ernat
ivesr
elat
ingt
oa
pr
oject
;Calcul
ateNPV ,
Prof
itabi
li
tyi
ndexandDiscount
edpaybackper
iodby10%andwhi ch
y
ouwoul
dchooseal
ter
nat
ivesandwhy
?cal
cul
ateI
RRWi
tht
hef
oll
owi
ngi
nfor
mat
ion:

Year A(
Rs.
) B(
Rs.
)

0 (
2,50,
000) (
2,60,
000)

1 1,
00,
000 1,
30,
000

2 1,
30,
000 1,
10,
000

3 1,
50,
000 1,
30,
000

4 1,
30,
000 1,
10,
000

5 1,
10,
000 1,
30,
000

Costofcapi
tal
forI
RR 10%&15% 10%&15%

AnsI
RR= 10.
19% 10.
11%

Sol
uti
on_

Cal
cul
ati
onofA

y
ear CI
F PV@10% PVCI
F Cummul
ati
ve
PVCI
F

1 1,
00,
000 0.
909 90,
900 90,
900

2 1,
30,
000 0.
826 1,
07,
380 1,
98,
280

3 1,
50,
000 0.
751 1,
12,
650 3,
10,
930

4 1,
30,
000 0.
683 88,
790 3,
99,
720

5 1,
10,
000 0.
621 68,
310 4,
68,
030

TOTAL 4,
68,
030

NPV=PVCIF-COF
4,
68,
030-2,
50,
000=Rs.2,
18,
030

Pr
ofi
tabi
li
tyindex=PVCIF/COF
4,
68,
030/2,50,
000=1.87

Di
scount
edpay
backper
iod=No.
ofy
ear
s+(
Requi
redamt/PVCI
Foft
henexty
ear
)*12mont
hs.
2y
ear
s+(
51,
720/1,
12,
650)*
12mont
hs

=2y
ear
s+5.
509mont
hs

=2y
ear
s6mont
hs