Capital Budgeting

Q.1. Suppose that you want to invest in Rs 1,00,000 project that you expect to

provide cash inflows of Rs 50,000 in the first year, Rs 25,000 the second year &

Rs 20,000 per year thereafter. What is the payback period?

Q.2. A company is considering two mutually exclusive proposals, X and Y.

Proposal X will require the purchase of machine X, for Rs 1,50,000 with no

salvage value but an increase in the level of working capital to the tune of Rs

50,000 over its life. The project will generate additional sales of Rs 1,30,000 and

require cash expenses of Rs 30,000 in each of the 5 years of its life.

Proposal Y will require the purchase of machine Y for Rs 2,50,000 with no

salvage value and additional working capital of Rs 70,000. The project is

expected to generate additional sales of Rs 2,00,000 with cash expenses

aggregating Rs 50,000.

Both the machines are subject to written down value method of depreciation at

the rate of 25 per cent. Assuming the company does not have any other asset in

the block of 25 per cent; has 12 per cent cost of capital and is subject to 35 per

cent tax, advise which machine it should purchase?

What course of action would you suggest if Machine X and Machine Y have

salvage values of Rs 10,000 and Rs 25,000 respectively?

Q.3. A company is considering a new project for which the investment data are

as follows:

Capital outlay Rs 2,00,000 Depreciation 20% p.a.

Forecasted annual income before charging depreciation, but after all other

charges are as follows:

Year 1 Rs 1,00,000

2 1,00,000

3 80,000

4 80,000

5 40,000

On the basis of the available data, set out calculation, illustrating and comparing the following methods of evaluating the return:

(a) Payback method. (b) NPV method

Q.4. A firm whose cost of capital is 10% is considering two mutually exclusive

projects X and Y, the details of which are:

Year Project X Project Y

Cost 0 Rs. 70,000 Rs. 70,000

Cash inflows 1 10,000 50,000

2 20,000 40,000

3 30,000 20,000

4 45,000 10,000

5 60,000 10,000

Compute: i. Net Present Value at 10%, ii. Pay Back Method

Q.5. A Company is considering the replacement of its existing machine, which is

obsolete and unable to meet the rapidly rising demand for its product. The

company is faced with two alternatives:

(i) To buy Machine A which is similar to the existing machine or

(ii) To go in for Machine B which is more expensive and has much greater capacity.

The cash flow at the present level of operations under the two alternatives are as follows: Cash flows (in lacs of Rs.) at the end of year:

0 1 2 3 4 5

Machine A -25 --- 5 20 14 14

Machine B -40 10 14 16 17 15

The company’s cost of capital is 10%. The finance manager tries to evaluate the machines by calculating the following:

1. Net Present Value; 2. Payback period