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Financial Management-Capital Budgeting:: Answer The Following Questions

The document contains 10 questions related to capital budgeting. Question 1 asks to calculate various capital budgeting metrics like NPV, IRR, payback period for two investment proposals. Question 2 asks to calculate NPV, IRR, MIRR for an investment in a new machine. Question 3 asks to calculate payback period, discounted payback period, NPV, MIRR for an investment in a machine.

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Mitali Julka
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206 views

Financial Management-Capital Budgeting:: Answer The Following Questions

The document contains 10 questions related to capital budgeting. Question 1 asks to calculate various capital budgeting metrics like NPV, IRR, payback period for two investment proposals. Question 2 asks to calculate NPV, IRR, MIRR for an investment in a new machine. Question 3 asks to calculate payback period, discounted payback period, NPV, MIRR for an investment in a machine.

Uploaded by

Mitali Julka
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Financial Management—Capital Budgeting:

Answer the following questions:


1. Sigma Ltd. is considering two mutually exclusive investment proposals. Both the
proposals would require an investment of Rs.50,00,000 each Company’s cost of
capital is 12% and the after tax cash inflows are as follows:
Year 1 2 3 4 5
CFAT:
Proposal 1. 18,00,000 25,00,000 30,00,000 22,00,000 12,00,000
Proposal 2. 35,00,000 25,00,000 15,00,000 10,00,000 6,00,000
Calculate: a) Accounting Rate of Return, b) Simple Pay back period, c) Discounted
Pay back period, d) Net Present Value, and e) Benefit Cost Ratio.

2. A company is considering an investment proposal to install a new machine. The


machine will cost Rs.25,00,000. It will have a working life of 5 years. The machine
will sell for Rs.5,00,000 after its working life. The company’s tax rate is 40%. It uses
straight line method of depreciation. Its cash flows before tax are estimated to be as
follows:
Year 1 2 3 4 5
Cash flows 4,00,000 4,40,000 5,60,000 6,00,000 10,00,000
Compute: a) Net present Value at 15% discount; b) Internal Rate of Return; and c)
Modified Internal Rate of Return assuming the cost of capital to be 15%.

3. A machine costing Rs.110 lakhs has a life of 10 years, at the end of which its
scrap value is likely to be Rs.10 lakhs. The firm’s cut-off rate (cost of capital) is 12%.
The machine is expected to yield an annual before tax profit (PBT) of Rs. 18 lakhs.
Tax rate is 30%. Depreciation is calculated on straight line method.
Ascertain: a) Simple Pay back period; b) Discounted Pay back period; c) Net Present
Value, d) Modified Internal Rate of return.

4. Your company is considering two mutually exclusive projects—A and B. Proposal a


involves an outlay of Rs.200 lakhs, and will generate an expected cash inflow after
tax of Rs. 50 lakhs per year for 6 years. Project B calls for an outlay of Rs.120 lakhs
and will produce an expected cash inflow after tax of Rs.28 lakhs per year for 6
years. The company’s cost of capital is 15%.
Calculate: a) NPV, b) Benefit Cost Ratio; and c) IRR, for both the projects.

5. Phoenix Company is considering two mutually excusive investment projects—P


and Q. The expected cash flows of these projects are as follows:
Year 0 1 2 3 4 5
Project P (1000) (1200) (600) (250) 2000 4000
Project Q (16000 200 400 600 800 700
Calculate: a) NPV, b) IRR and c) MIRR for the above projects on the basis of 15%
cost of capital.

6. O Ltd. has under consideration two projects A and B. The details relating to two
projects are given below:-
Particulars Rs.(Lakhs)
Project A Project B
Investment required 95 200
Estimated net cash flows
(PAT + Depreciation at the end of year 1 40 80
(PAT +Depreciation) at the end of year 2 40 80
(PAT +Depreciation) at the end of year 3 45 120
The cost of capital of the company is 12% using Net Present Value Technique, which
project would you recommend?
PV of Re.1 at the end of each year during the three years period is given below:
Year 1 2 3
PV Factor at 12% 0.892 0.797 0.712

7. A company is considering an investment proposal involving a cost of Rs. 8 lakhs.


The expected life of the project is 8 years with no salvage value. The tax rate is
40%. The firm uses straight line method of depreciation. The estimated profits
before tax from the project are as follows:
Year 1 2 3 4 5 6 7 8
PBT in lakhs 1.5 1.6 1.7 1.8 2.0 2.1 2.2 3.0
Compute the Net Present Value at 10% discount. Also calculate the IRR.

8. a) Define Capital Budgeting. State briefly its features.


b) Explain in brief the steps involved in capital budgeting process.
c) Explain the Discounted Cash Flow (DCF) Techniques and Non-Discounted Cash
Flow Techniques.

9. a) Critically evaluate the Present Value method used in capital budgeting


decisions.
b) What is pay back period? Evaluate payback as an investment criterion.
c) Describe the commonly found categories in project classification for
capital budgeting.

10. S.Murlidharan Ltd has a machine with an additional life of 5 years which costs
Rs.10,00,000 and has a book value of Rs.4,00,000. A new machine costing
Rs.20,00,000 is available Though its capacity is the same as that of old machine, it
will mean a saving in variable costs to the extent of Rs.7,00,000 per annum. The life
of the machine will be 5 years at the end of which it will have a scrap value of
Rs.2,00,000. The income tax is 40%. And as a policy the firm does not make an
investment if the yield is less than 12% p.a. The old machine, if sold, will realize
Rs.1,00,000. It will have no salvage value if sold at the end of 5 years.
Advise S.Murlidharan Ltd. whether or not old machine should be replaced? Capital
gains on sale of old machine is also subject to the tax rate of 40%.

Hint: It is a problem on replacement of an asset.


1. Savings in variable cost Rs. 7,00,000 should be treated as incremental
cash inflow before incremental depreciation (Depreciation on the new machine—
depreciation on the old machine—360000--80000) and tax.
2. Initial Outlay on the machine is to be calculated by subtracting the sale
value of the old machine and the tax saving of Rs. 120000 because of capital loss
(40% of Book Value of the old machine—sale proceeds of the old machine i.e.
4,00,000—1,00,000)

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