Professional Documents
Culture Documents
CA IPC Capital Budgeting Most Important Questions 1TR8KKBF
CA IPC Capital Budgeting Most Important Questions 1TR8KKBF
MOST IMPORTANT
REVISIONARY
NOTES OF
CAPITAL
BUDGETING
Specifically for Students of CA-IPC
2014
Written & Compiled by:-
Section 1:- Calculation of NPV, IRR (Internal Rate of Return), Pay Back
Period, Discounted Payback Period, Average Rate of
Return (ARR), Profitability Index Method (PI)
Section 2:- Savings per annum and Additional Cost per annum
Section 3:- Equal Annual Cost (EAC)
Section 4:- NPV-IRR Conflict
Section 5:- Reverse Calculation for NPV, Profitability Index Method,
Cost of Capital
Section 6:- Capital Rationing
Section 7:- Replacement Decisions
Section 8:- Leasing Decisions (It is now in CA FINAL)
Section 2:- Savings per annum and Additional Cost per annum
Particulars Machine
Annual savings:-
Savings in Manual Labour Cost p.a. 200 x 10,000 =
20,00,000
Total Savings (A) 20,00,000
Annual Additional Costs:-
Operating Cost p.a. 5,00,000
Total Cost (B) 5,00,000
Annual Savings/EBDT (A-B) 15,00,000
Less: Depreciation 2,00,000
EBT 13,00,000
Less: Tax 4,55,000
EAT 8,45,000
Add: Depreciation 2,00,000
CFAT per annum 10,45,000
Sum of PVF for 1-10 years @ 10% 6.145
PV of Cash Inflow 6.145 x 10,45,000 =
64,21,525
6|CA SUKESH BHATIA CLASSES, PH – 9811270284, 9971086655
1/27, Near Gurudwara, Lalita Park, Laxmi Nagar, Delhi-92
PV of Cash Outflow 20,00,000
NPV 44,21,525
Machines X Y
Purchase Cost (in Rs.) 5,50,000 4,00,000
Life of Machines (in 3 2
Years)
Running/Operating 1,25,000 1,50,000
Cost of Machine per
7|CA SUKESH BHATIA CLASSES, PH – 9811270284, 9971086655
1/27, Near Gurudwara, Lalita Park, Laxmi Nagar, Delhi-92
year (in Rs.)
Sum of PVF for 1-3 2.4019 ----
years @ 12%
Sum of PVF for 1-2 ---- 1.6901
years @ 12%
Present Value of 1,25,000 x 2.4019 = 1,50,000 x 1.6901 =
Running/Operating 3,00,237.50 2,53,515
Cost of Machines (in
Rs.)
Present Value of Cash 5,50,000 + 4,00,000 + 2,53,515 =
Outflow (in Rs.) 3,00,237.50 = 6,53,515
8,50,237.50
Equal Annual Cost 8,50,237.50 6,53,515
= 3,53,985.39 = 3,86,672.39
2.4019 1.6901
(EAC) (in Rs.)
The company should buy Machine X because its Equal Annual Cost
(EAC) is less than that of Machine Y.
Required:-
a) Estimate NPV of projects using 15% as hurdle rate.
b) Estimate IRR of projects.
c) Why there is a conflict in the project choice by using NPV and
IRR criterion ?
d) Which criterion you will use in such a situation ? Estimate the
value at that criterion. Make a project choice.
Answer 5:- Calculate NPV & IRR of both projects using Hurdle Rate as
Discounting Rate. It will give following results:-
Particulars Project P Project J
NPV Rs. 5,375 Rs. 3,806
Ranking on the basis Ist IInd
of NPV
IRR 20.15% 25.30%
Ranking on the basis IInd Ist
of IRR
Project P Project J
Equal Annual Flows Rs. 5,375 Rs. 3,806
= Rs. 1,420 = Rs. 1,668
3.7845 2.2832
10 | C A S U K E S H B H A T I A C L A S S E S , P H – 9 8 1 1 2 7 0 2 8 4 , 9 9 7 1 0 8 6 6 5 5
1/27, Near Gurudwara, Lalita Park, Laxmi Nagar, Delhi-92
20,000). Now, the amount invested is same hence we cannot
mention this point in exams.
b) Differences in Project Lives (6 years and 3 years). Now, the lives
of projects are same hence we cannot mention this point in
exams.
c) Variability of Cash Inflows of the Projects. Project P has lower
initial cash flows and heavy later inflows. However, Project J has
heavy initial inflows in the lower inflows in the later periods.
This will distort the analysis under IRR. NPV is a technique which
takes into account, the variability of cash flows. Hence, NPV
should be preferred over IRR in case of conflict.
Answer 7:-
a) At IRR of 15%,
= 3.353 years
PV of Cash Inflow
c) Profitability Index =
PV of Cash Outflow
PV of Cash Outflow
1.05 =
3,21,888