1. A company has to choose one of the two alternative machines.

Calculate
the net present value and suggest the profitable machine.

Machine A B
Cost of machine (Rs.) 1,30,000 1,30,000
Working life (years) 5 5
Profit before depreciation & tax (Rs.)
I Year 60,000 80,000
II Year 70,000 1,00,000
III Year 80,000 80,000
IV Year 60,000 70,000
V Year 40,000 60,000
Rate of income tax 50% 50%

SOLUTION :

Depreciation = 1,30,000 - 0 ÷ 5

=26,000

Machine A

(1) (2) (3) (4) (5) (6) (7) (8) (9)

YEAR PBDBT DEPRE PADBT TAX@5 PADA PBDAT PV@1 PVCIF
CIATIO (4=2-3) 0% T (7=3+6) 0%
N (6=4-5)

1 60,000 26,000 34,000 17,000 17,000 43,000 0.909 39,087

2 70,000 26,000 44,000 22,000 22,000 48,000 0.826 39,648
3 80,000 26,000 54,000 27,000 27,000 53,000 0.751 39,803
4 60,000 26,000 34,000 17,000 17,000 43,000 0.683 29,369
5 40,000 26,000 14,000 7,000 7,000 33,000 0.621 20,493

PVCIF 1,68,400

PVCO -1,30,00
F 0

NPV 38,400
Machine B

(1) (2) (3) (4) (5) (6) (7) (8) (9)

YEAR PBDBT DEPRE PADBT TAX@5 PADA PBDAT PV@10 PVCIF
CIATIO (4=2-3) 0% T (7=3+6) %
N (6=4-5)

1 80,000 26,000 54,000 27,000 27,000 53,000 0.909 48,177

2 1,00,000 26,000 74,000 37,000 37,000 63,000 0.826 52,038
3 80,000 26,000 54,000 27,000 27,000 53,000 0.751 39,803
4 70,000 26,000 44,000 22,000 22,000 48,000 0.683 32,784
5 60,000 26,000 34,000 17,000 17,000 43,000 0.621 26,703

PVCIF 1,99,50
5

PVCOF -1,30,00
0

NPV 69,505

Machine B NPV is greater

Hence, Select machine B.

2. X Ltd. is considering the purchase of a machine. Two machines are

available E and F. The cost of each machine is Rs. 60,000. Each machine
has an expected life of 5 years. Profits after depreciation and before tax
during the expected life of the machine are given below.

Year Machine E (Rs.) Machine F (Rs.)

1 15,000 5,000
2 20,000 15,000
3 25,000 20,000
4 15,000 30,000
5 10,000 20,000
Total 85,000 90,000
Find ARR. Ascertain which of the alternatives will be more profitable. The
average rate of tax may be taken as 50%.

SOLUTION :

Depreciation = 60,000 - 0 ÷ 5

= 12,000

Machine E

YEAR PADBT TAX@50% PADAT DEPRECIAT PBDAT

ION

1 15,000 7,500 7,500 12,000 19,500

2 20,000 10,000 10,000 12,000 22,000
3 25,000 12,500 12,500 12,000 24,500
4 15,000 7,500 7,500 12,000 19,500
5 10,000 5,000 5,000 12,000 17,000

ARR (ORG) = Annual average net earnings ÷

Orginal investment × 100

= 42,500 ÷ 5 ÷ 60,000 × 100

= 8,500 ÷ 600

= 14%

ARR (AVE) = Annual average net earnings ÷

Average investment × 100

= 42,500 ÷ 5 ÷ 60,000 ÷ 2 × 100

= 8,500 ÷ 30,000 × 100

= 28%

Machine F
 YEAR PADBT TAX@50% PADAT DEPRECIAT PBDAT
ION

1 5,000 2,500 2,500 12,000 14,500

2 15,000 7,500 7,500 12,000 19,500
3 20,000 10,000 10,000 12,000 22,000
4 30,000 15,000 15,000 12,000 27,000
5 20,000 10,000 10,000 12,000 22,000

ARR (ORG) = Annual average net earnings ÷

Orginal investment × 100

= 45,000 ÷ 5 ÷ 60,000 × 100

= 9,000 ÷ 600

= 15%

ARR (AVE) =Annual average net earnings ÷

Average investment × 100

= 45,000 ÷ 5 ÷ 60,000 ÷ 2 × 100

= 9,000 ÷ 30,000 × 100

= 30%

Machine F is greater

Hence, machine F is selected.

3. Project ‘M’ initially costs Rs. 50,000. It generates following net cash
flows:

Year Net Cash inflow

(Rs.)
1 18,000
2 16,000
3 14,000
 4 12,000
5 10,000

Taking cut-off rate as 10%, find Net present value. Suggest whether the project
should be accepted or not.

SOLUTION :

YEAR NCIF PV@10% PVCIF

1 18,000 0.909 16,362

2 16,000 0.826 13,216
3 14,000 0.751 10,514
4 12,000 0.683 8,196
5 10,000 0.621 6,210

PVCIF 54,498

PVCOF -50,000

NPV 4,498

NPV is greater

Hence, Project can be accepted.

4. Initial investment Rs. 20,000. Net cash inflows – 1​st​ year Rs.2,000; 2​nd
year Rs.2,000; from 3​rd​ year to 10​th​ year Rs.2,500 each.

Work out Net present value with a discount rate at 10% and express whether the
investment will be worthwhile.

SOLUTION :
Initial investment = 20,000

Discount rate = 10%

CIF 1 Year = 2,000

2 Year = 2,000

3 - 10 Year = 2,500

NPV = PVCIF - PVCOF

= [ ( 2,000 ×PV​10%,1​) + ( 2,000 × PV​10%,2​) + 2,500 ( PV​10%,10​ - PV​10%,3​) ] - 20,000

= [ (2,000 ×0.909) + (2,000 × 0.826) + 2,500(6.145 - 1.736) ] - 20,000

= [ (1818 + 1652 +2,500(4.409) ) ] - 20,000

= [ (1818 + 1652 + 11,022.5) ] - 20,000

= 14,492.5 - 20,000

NPV = -5,507.5

5. Calculate the Internal rate of return for the following projects and decide
which is the most profitable project:

Particulars A (Rs.) B (Rs.) C (Rs.)

Initial cost 60,000 66,000 72,000
Returns: End of year 1 3,000 36,000 12,000
2 12,000 24,000 18,000
3 18,000 - 12,000
4 24,000 - 30,000
5 30,000 18,000 12,000
6 (-) 6000 12,000 6,000

SOLUTION :

Project A

Initial investment = 60,000

Life time = 6 Years

Assuming 10%

YEAR CIF PV@10% PVCIF

1 3,000 0.909 2,727

2 12,000 0.826 9,912
3 18,000 0.751 13,518
4 24,000 0.683 16,392
5 30,000 0.621 18,630
6 -6,000 0.564 -3,384

PVCIF 57,795

PVCOF -60,000

NPV -2,205

Assuming 5%

YEAR CIF PV@5% PVCIF

1 3,000 0.952 2,856

2 12,000 0.907 10,884
3 18,000 0.864 15,562
4 24,000 0.823 19,952
5 30,000 0.784 23,520
6 -6,000 0.746 -4,476

PVCIF 68,088

PVCOF -60,000

NPV 8,088

NPV @ 5%. = 8,088

NPV @ 10% = -2,205

IRR = LR + [ ( NPV of LR ÷ NPV of LR - NPV of HR ) × Difference of HR & LR ]

= 5 + [ ( 8,088 ÷ 8,088 - (-2,205) ) × 5 ]

 = 5 + [ 8,088 ÷ 10,293 × 5 ]

= 5 + 3.9285

IRR = 8.93%

Project B

Initial investment = 66,000

Lif time = 6 Years

Assuming 10%

YEAR CIF PV@10% PVCIF

1 36,000 0.909 32,724

2 24,000 0.826 19,824
3 - 0.751 -
4 - 0.683 -
5 18,000 0.621 11,177
6 12,000 0.564 6,768

PVCIF 70,494

PVCOF -66,000

NPV 4,494

Assuming 15%

YEAR CIF PV@15% PVCIF

1 36,000 0.870 31,320

2 24,000 0.756 18,144
3 - 0.658 -
4 - 0.572 -
5 18,000 0.497 8,946
6 12,000 0.432 5,184

PVCIF 63,594

PVCOF -66,000

NPV -2,406

NPV @ 10% = 4,494

NPV @ 15% = -2,406

IRR = LR + [ ( NPV of LR ÷ NPV of LR - NPV of HR ) × Difference of HR & LR ]

= 10 + [ ( 4,494 ÷ 4,494 - (-2,406) ) × 5 ]

= 10 + [ (4,494 ÷ 6,900) × 5 ]

= 10 + 3.2565

IRR = 13.26%

Project C

Initial investment = 72,000

Life time = 6 Years

Assuming 10%

YEAR CIF PV@10% PVCIF

1 12,000 0.909 10,908

2 18,000 0.826 14,868
3 12,000 0.751 9,012
4 30,000 0.683 20,490
5 12,000 0.621 7,452
6 6,000 0.564 3,384

PVCIF 66,144

PVCOF -72,000

NPV -5,886

YEAR CIF PV@5% PVCIF

1 12,000 0.952 11,424

2 18,000 0.907 16,326
3 12,000 0.864 10,368
4 30,000 0.823 24,690
5 12,000 0.784 9,408
6 6,000 0.746 4,476

PVCIF 76,692
 PVCOF -72,000

NPV 4,692

NPV @ 10% = -5,886

NPV @ 5% = 4,692

IRR = LR + [ ( NPV of LR ÷ NPV of LR - NPV of HR ) × Difference of HR & LR ]

= 5 + [ ( 4,692 ÷ 4,692 - (-5,886) ) × 5 ]

= 5 + [ ( 4,692 ÷ 10,578 ) × 5 ]

= 5 + 2.2175

IRR = 7.22%

IRR of project A = 8.93%

IRR of project B = 13.26%

IRR of project C = 7.22%

Project B has greater NPV.

Hence, project B is more profitable.

6. A company is considering an investment proposal to install new milling

controls. The project will cost Rs. 50,000. The facility has a life
expectancy of 5 years and no salvage value. The company’s tax rate is
55%. The firm uses straight line method of depreciation. The minimum
rate of return of the project is 10%. The estimated profits before
depreciation and taxes from the proposed investment proposal are as
follows:

Year 1 2 3 4 5
Profits (Rs.) 10,000 11,000 14,000 15,000 25,000
Compute the following:

(a) Pay back period.

(b) Average rate of return.
(c) Net present value
(d) Profitability index
(e) Internal rate of return

SOLUTION :

Depreciation = Cost of project - scrap value ÷ life time

= 50,000 - 0 ÷ 5

= 10,000

(1) (2) (3) (4) (5) (6) (7) (8)

YEAR PBDBT DEPRE PADB TAX@ PADA PBDA CIF
CIATI T 55% T T
ON (4=2-3) (6=4-5) (7=6+3
)
1 10,000 10,000 0 0 0 10,000 10,000
2 11,000 10,000 1,000 550 450 10,450 20,450
3 14,000 10,000 4,000 2,200 1,800 11,800 32,250
4 15,000 10,000 5,000 2,750 2,250 12,250 44,500
5 25,000 10,000 15,000 8,250 6,750 16,750 61,250

(A). Pay Back Period :

PBP = 4years & [ ( 12 ÷ 16,750) × ( 50,000 - 44,500 ) ) ]

= 4years & [ (12 ÷ 16,750 × 5,500)

PBP = 4years & 3.9 months

(B). Average Rate Of Return :
ARR (ORG) = Annual average net earnings ÷

Orginal investment × 100

= 11,250 ÷ 5 ÷ 50,000 × 100

= 2,250 ÷ 500

ARR (ORG) = 4.5%

ARR (AVE) =Annual average net earnings ÷

Average investment × 100

= 11,250 ÷ 5 ÷ 50,000 ÷ 2 × 100

= 11,250 ÷ 25,000 × 100

ARR (AVE) = 9%

(C). Net Profit Value

YEAR CIF PV@10% PVCIF

1 10,000 0.909 9,090
0.826
2 10,450 8,631.7
0.751
3 11,800 0.683 8,861.8
4 12,250 0.621 8,655.75
5 16,750 0.564 10,401.75
PVCIF 45,352
PVCOF -50,000
NPV -4,648

Assuming at 5%

YEAR CIF PV@5% PVCIF

1 10,000 0.952 9,520
 2 10,450 0.907 9,478.15
3 11,800 0.864 10,195.2
4 12,250 0.823 10,081.75
5 16,750 0.784 13,132
PVCIF 52,407
PVCOF -50,000
NPV 2,407

NPV @ 10% = -4,648

NPV @ 5% = 2,407

(4). Internal Rate Of Return :

IRR = LR + [ ( NPV of LR ÷ NPV of LR - NPV of HR ) × Difference of HR & LR ]

= 5 + [ ( 2,407 ÷ 2,407 - (-4,648) ) × 5 ]

= 5 + [ 2,407 ÷ 7,055 × 5 ]

= 5 + 1.71

IRR = 6.71%

(5). Profitably Index :

PI​gross =
​ PVCIF ÷ PVCOF

= 52,407 ÷ 50,000

PI​gross​ = 1.05

PI​Net ​ = PI​gross​ -1

= 1.05 - 1

PI​Net ​ = 0.05