Capital Budgeting

P1.An investor issues a deep discount Bond for Rs.5,000 today and will mature in 15 years for Rs.20,000. Advise an
investor whose opportunity rate of return 11%?
Solution:
Bond's issue price today Year Cash Flow
Redemption Value 0
Tenure (Years) 1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
IRR on Bonds Rate
 P2.A firm is evaluating a proposal costing Rs.1,60,000 and expected to generate cash flows of Rs.
40,000, Rs.60,000, Rs.50,000, Rs.50,000 and Rs. 40,000. there is no salvage value there after.
Find out the IRR of the proposal.
Should it be taken up if the hurdle rate of the firm is 12%?

Solution:
Year Cash Flows

0 -160000
1 40000
2 60000
3 50000
4 50000
5 40000

Internal Rate of Return (IRR)

IRR 15%
 P3.Hunny Projects Ltd. Is evaluating two mutually exclusive investment proposals X and Y, The company's required rate
of return from such projects is 10%. The cash flows pattern of both the proposals are given. Evaluate the proposals as
per NPV and IRR methods:

Solution:
Year X Y
0 60000 60000 Rate 10%
1 50000 5000 year x y
2 25000 30000 0 -60000 -60000
3 5000 55000 1 50000 5000
2 25000 30000
NPV 3 5000 55000
PV $69,872.28 $70,661.16
IRR
Npv Pv of cash inflow - Pv of cash outflow
$9,872.28 $10,661.16

IRR 23% 17%

 P4.A Business firm has to chose one of the two proposals.The relevant data for both of them is as follows:
Projects A B
Initial Investment 150000 300000
Expected Cash Flows at the 40000 80000
end of Year 1
Year 2 56000 112000
Year 3 60000 120000
Year 4 45000 90000
Year 5 65000 130000
Evaluate both the projects using financial function NPV(at 12% rate of Interest) and IRR and recommend which project should be accepted.

Solution:
Project A Project B
Rate 12% 12%
Cash Invested -150000 -300000
CF1 40000 80000
CF2 56000 112000
CF3 60000 120000
CF4 45000 90000
CF5 65000 130000

Project A Project B Project to be selected

PV 188545.02 377090.03 Project ?

NPV 38545.02 77090.03

IRR 21% 21% Project ?

hould be accepted.

Project B should Selected due to higher npv as compared to project A

 P5. RS ltd. is considering investing in a project requiring a capital outlay of Rs.1,00,000. Its estimated CFAT for its
year life are: Calculate the IRR for the above proj

Solution:
Initial Investment 100000 Year CFAT
1 60000
Life 5 2 50000
3 40000
4 10000
5 5000
Total Cash inflows 165000

Average annual CFAT 33000

Payback period 1.8Years

Rs.1,00,000. Its estimated CFAT for its 5
Calculate the IRR for the above project.

Cumulative CFAT
60000
110000
150000
160000
165000

N 1
I 100000
Ccn 60000
Cn+1 50000
P6.
GIVEN:

Details Machine 1 Machine 2 Machine 3

Initial investment 500000 500000 500000
Estimated sales 400000 400000 450000

Estimated Cost of production

Direct Material and Labour 35000 60000 48000
Factory Overheads 65000 40000 36000
Administration Cost 30000 15000 36000
Selling and Distribution Cost 10000 10000 10000

Depreciation 230000 150000 155000

Total Cost of Production 140000 125000 130000

Scrap Value 40000 50000 35000 Income Tax Rate

Economic Life 2 3 3

Cash Flows After Tax

Payback period 1.992031873 2.1052631579 1.848428835

Sales 400000 400000 450000

cost 140000 125000 130000
CFBT(sales-cost) 260000 275000 320000
less dep 230000 150000 155000
EBT 30000 125000 165000
less tax 9000 37500 49500
EAT 21000 87500 115500
Plus Dep 230000 150000 155000
CFAT 251000 237500 270500
 Q.Xerox ltd. Has decided to purchase a machine to augment the company’s installed capacity to meet the
growing demands for the products. There are three machines under consideration of the management. The
relevant details include estimated yearly expenditure and sales are given in the table. The rate of Income tax
is 30%
The economic life of Machine 1 is 2years, while it is 3 years for other two. The scrap values are 40,000,
50,000 and 35,000 respectively.

You are required to find the most profitable investment based on “Payback Period”.

30%
 P7. Xerox Ltd. Is considering two additional mutually exclusive projects. The after tax cash flows associated with these
projects are given in the table. The required rate of return on these projects is 11%:
Advise as to which project will be chosen by way of: NPV and IRR?
Which project should be accepted? Why?

Solution:
Calculation of NPV and IRR
Year Project A Project B
0 -100000 -100000
1 32,000 0
2 20,000 0
3 32,000 0
4 35,000 0
5 45,000 200000

Opportunity Cost of Capital 11%

PV $118,220.30 $118,690.27
NPV 18220.30 18690.27

IRR 17.46% 14.87% Project A should be selected due to higher irr as compared to Project B
rr as compared to Project B
 P8. The ABC Ltd is in the process of selecting a capital project. The details of 2 Capital projects A and B identifie
Project A Project B
Rate of Interest 12% 12%
Cost of Project 500000 550000
Cash Inflows Year 1 400000 20000
Year 2 60000 500000
Year 3 50000 60000
Year 4 70000 70000
Year 5 80000 80000

You are required to evaluate the above capital budgeting projects and recommend the project to be implemented
the basis of:
a) IRR Method
b) NPV Method using 12% Interest Rate
Calculate the value of NPV of “Project A” at the rate of interest of 10% to 15%
Draw a suitable chart for NPV of “Project A” at the rate of interest of 10% to 15%

Solution:

Project A
Rate 12%
Cost -500000
CF1 400000
CF2 60000
CF3 50000
CF4 70000
CF5 80000

Project A Project B
NPV 30443.92 -958.69

IRR 16% 12%

Present Value $530,443.92 $549,041.31

Profitability Index $1.06 $1.00

Rate of returns 10% 11%

present Value $548,273.53 $539,204.55
NPV of Project A 48273.53 39204.55
s of 2 Capital projects A and B identified by the company are provided below:

ommend the project to be implemented so that the company earns maximum profit on

15%
to 15%

Project B
12%
-550000
20000
500000
60000
70000
80000

Project to be selected
Project ?
Project A should be selected to positive npv and higher irr
Project ?

Project ?

12% 13% 14% 15%

$530,443.92 $521,976.72 $513,788.93 $505,867.38
30443.92 21976.72 13788.93 5867.38
nd higher irr
 P9.An investor invests Rs.35,000 on January 1, 2017 in a project which is
expected to provide the following cash flows:
Rs.6,000 on March 1, 2017
Rs.8,000 on Oct 30,2017
Rs.19,000 on Dec 15, 2018
Rs.7,000 on April 1, 2018

Solution: Solution:
Values Occurrence

-35000 1-Jan-17
6000 1-Mar-17
8000 30-Oct-17
7000 1-Apr-18
19000 15-Dec-18

Rate 12% present Value ###

Internal Rate of Return 5% Net Present Value
###