CAPITAL BUDGETING/ INVESTMENT DECISIONS

Q1. DLF Ltd. Is implementing a project with an initial capital outlay of Rs. 8,000. Its cashflows are as under:

YEAR CASH INFLOW

1 6,000
2 2,000
3 1,000
4 5,000
The expected rate of return is 12% p.a.
Calculate the discounted pay back period of the project.

Q2. A firm has an investment opportunity costing Rs. 50,000 with following expected Net Cashflows (i.e. after taxes and
before depreciation)
YEAR CASH INFLOW
1 8,000
2 9,000
3 10,000
4 13,000
5 12,000
6 10,000
7 8,000
8 2,000
Using 10% as the cost of capital, evaluate the project by
(i) NPV
(ii) PI

Q3. A company has to make a choice between two projects namely A and B. the initial capital outlay of the two projects
are Rs. 1,35,000 and Rs. 2,40,000 respectively for A and B. There will no scrap value at the end of the life of both the
projects. The opportunity cost of capital of the company is 16%. The annual incomes re as under:
YEAR PROJECT A PROJECT B
1 - 60,000
2 30,000 84,000
3 1,32,000 96,000
4 84,000 1,02,000
5 84,000 90,000
You are required to calculate for each project Net Present Value and Profitability Index; and give your recommendation.

Q4. Evaluate a project by (i) NPV and (ii) PI methods which requires an initial outlay of Rs. 1,00,000 and generates
revenue of Rs. 60,000 , Rs. 30,000 , Rs. 20,000 , Rs. 50,000 and Rs. 50,000 from the first year to the end of fifth year. The
required rate of return is 10% and income tax rate is 50%. The project has a life of 5 years and will be depreciated on
straight line basis.

Q5. An enterprise can make either of two investments at the beginning of 2000. Assuming a required rate of return of
10% p.a. Evaluate the investment proposals under NPV and PI methods.
The forecast particulars are given below:
 PARTICULARS PROPOSAL A PROPOSAL B
Cost of investment (Rs) 20,000 28,000
Life (years) 4 5
Scrap value Nil Nil
Net income (after depreciation and tax):
End of 2000 500 Nil
2001 2,000 3,400
2002 3,500 3,400
2003 2,500 3,400
2004 - 3,400
It is estimated that each of the projects will require an additional working capital of Rs. 2,000 which will be received back
in full after the expiry of each project life. Depreciation is provided under the straight line method.

Q6. Avanti products Ltd. Wants to introduce a new product with estimated life of 5 years.
The manufacturing equipment of Rs. 2,50,000 with scrap value of Rs. 15,000 at the end of 5 years. The working capital
requirement is Rs. 20,000which will be released after 5 years.
The annual cashflows are:
YEARS RS.
1 1,25,000
2 1,50,000
3 1,87,500
4 1,80,000
5 1,12,500
Depreciation to be charged under straight line method. Tax applicable @ 40%.
Evaluate proposal under (i) NPV (ii) PI alternatives.

Q7. S Ltd. Has Rs. 10,00,000 allocated for capital budgeting purposes. The following proposals and associated
profitability indexes have been determined.
PROJECT AMOUNT PROFITABILITY
INDEX
1 3,00,000 1.22
2 1,50,000 0.95
3 3,50,000 1.20
4 4,50,000 1.18
5 2,00,000 1.20
6 4,00,000 1.05
Which of the above investments should be undertaken? Assume that projects are indivisible and there is no alternative
use of money allocated for capital budgeting.

Q8. A firm can make investment in either of the two projects. The firm anticipates its cost of capital to be 10% and the
net (after tax) cash flows of the projects for five years are as follows:
YEAR PROJECT A PROJECT B
0 (500) (500)
1 85 480
2 200 100
3 240 70
4 220 30
5 70 20
Required:
(i) Calculate the NPV and IRR of each project.
 (ii) State with reasons which project you would recommend.
(iii) Explain the inconsistency in ranking of two projects.

Q9. A company is considering a proposal of taking up a new project which requires an investment of Rs. 400 lakh on
machinery and other assets. The project is expected to yield the following earnings (before depreciation and taxes) over
the next five years:
YEAR EARNINGS (RS.
IN LAKH)
1 160
2 160
3 180
4 180
5 150
The cost of raising the additional capital is 12% and assets have to be depreciated at 20% on WDV basis. The scrap value
at the end of the 5 years period may be taken as zero. Income tax applicable to the company is 50%.
You are required to calculate the net present value of the project and advise the management to take appropriate
decision. Also, calculate the internal rate of returns of the project.
Note: present value of Re. 1 at different rates of interest is as follows:
YEAR 10% 12% 14% 16%
1 0.91 0.89 0.88 0.86
2 0.83 0.80 0.77 0.74
3 0.75 0.71 0.67 0.64
4 0.68 0.64 0.59 0.55
5 0.62 0.57 0.52 0.48

Q10. A hospital is considering to purchase a diagnostic machine costing Rs. 80,000. The projected life of the machine is 8
years and has an expected salvage value of Rs. 6,000 at the end of 8 years. The annual operating cost of the machine is
Rs. 7,500. It is expected to generate revenues of Rs. 40,000 per year for eight years. Presently, the hospital is
outsourcing the diagnostic work and is earning commission income of Rs. 12,000 per annum; net of taxes. Cost of capital
is 10%.
Required:
Whether it would be profitable for the hospital to purchase the new machine? Give your recommendation under:
(i) Net present value method.
(ii) Profitability index method.