INSTITUTE OF INNOVATION IN TECHNOLOGY & MANAGEMENT

PAPER: FINANCIAL MANAGEMENT PAPER CODE: BBA 204

PROGRAMME: BBA IV SEMESTER

ASSIGNMENT-3

UNIT-2: CAPITAL BUDGETING

Q1: Calculate payback period, Net present value, IRR and PI for machines A and B which would you
choose? Why k=12%

Year A B
0 20,00,000 30,00,000
1 4,00,000 4,00,000
2 4,00,000 4,00,000
3 4,00,000 4,00,000
4 4,00,000 4,00,000
5 4,00,000 4,00,000
6 4,00,000 3,00,000
7 4,00,000 3,00,000
8 4,00,000 2,00,000
9 4,00,000 2,00,000
10 4,00,000 2,00,000
Answers [A= 5years, 2, 60,000, 1.13; B= 9years, 10, 52,900, 0.649]

Q2: A company plans to purchase a machine of Rs.12 lakhs.The future cash inflows are expected to be
Rs. 5 lakhs, 4 lakhs and 6 lakhs. (a) Calculate NPV and PI when minimum cost of capital is 10% and the
life of machine is 3years (b) would you still purchase the machine if the cost of capital is 12%? Answers
[a] 35,500, 1.029 [b] 8,600,0.992.

Q3: Find NPV if project A and B are evaluated. Which of these should be accepted? Equipment A costs
rs.75, 000 and brings a net cash flow of Rs 20,000 per year for 6 years. A substitutes equipment B would
cost rs.50, 000 and generate net cash flow of Rs 15,000 per year for 6 years .the required rate of return for
both the equipment is 11%?

Q4: A company is contemplating to purchase a machine. Two machines A and B are available, each
costing Rs. 5 lakhs. In comparing the profitability of the machines, a discounting rate of 10% is to be used
and machine is to be written off in 5years by straight line method of depreciation with nil residual value.
Cash inflows after tax are expected as follows:

Year Machine A [in lakhs] Machine B [in lakhs]

1 1.5 0.5
2 2.0 1.5
3 2.5 2.0
4 1.5 3.0
5 1.0 2.0

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Q5: XY ltd. wants to replace its existing plant. It has received three mutually exclusive proposals are
expected to cost Rs. 2,50,000 each and have an estimated life of 5years,4years,3years respectively. The
company’s required rate of return is 10%.the anticipated net cash inflow after taxes for the three plants are
as follows:

Years Plant 1 Plant 2 Plant 3

1 80,000 1,10,000 1,30,000
2 60,000 90,000 1,10,000
3 60,000 85,000 20,000
4 60,000 35,000 -
5 1,80,000 - -
Which of the above proposals would you recommend to the management acceptance using NPV
technique for evaluation?

Years PVF[10%]
1 0.909
2 0.826
3 0.751
4 0.683
5 0.621

Q6: Payoff ltd. Is producing articles mostly by manual labour and is considering replacing it by a new
machine. There are two alternative models M and N of the new machine, prepare a statement of
profitability showing the payback period from the following information:

Particulars Machine M Machine N

Estimated life of machine 4 years 5 years
Cost of machine 9000 18000
Estimated saving in scrap 500 800
Estimated saving in direct wages 6000 8000
Additional cost of maintenance 800 1000
Additional cost of supervision 1200 1800

Ignore taxation.

Q7: ABC Company has an investment opportunity costing Rs 1 lakh with the following expected cash
inflow [i.e after taxes and before depreciation]

Years Inflows [rs]

1 17,000
2 17,000
3 17,000
4 17,000
5 17,000
6 18,000
7 20,000
8 15,000
9 14,000
10 12,000

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Using 10% as the cost of capital [rate of discount], determine the NPV and PI.

Q8: Aroma Finance co. is considering two mutually exclusive projects. The expected values for each
project’s cash flows are as follows:

year Project A Project B

0 (300,000) (300,000)

1 100,000 200,000

2 200,000 200,000

3 200,000 200,000

4 300,000 300,000

5 300,000 400,000

The company has decided to evaluate these projects using the certainty equivalent method. The certainty
equivalent coefficients for each project’s cash flow are as follows:

Year Project A Project B

0 1.00 1.00

1 0.95 0.90

2 0.90 0.80

3 0.85 0.70

4 0.80 0.60

5 0.75 0.50

Given that this company’s normal required rate of return is 15% and the after tax risk free rate is 8%,
which project should be selected?

[Answer: NPV OF project A: 406,835 and project B: 383,720]

Q9From the following data, state which project is best:

year A B

0 -10000 -10000

1 4000 5000

2 4000 6000

3 2000 3000

Riskless discount rate is 5%.project A is less risky as compare to project B. the management considers
risk premium rates at 5% and 10% respectively appropriate for discounting the cash inflows.

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Q10: The management of P ltd is considering selecting a machine out of two mutually exclusive
machines. The company’s cost of capital is 12% and corporate tax rate for the company is 30%. Details of
the machines are as follows:

Machine 1 Machine 2

Cost of machine 1,000,000 1,500,000

Expected life 5years 6years

Annual income before tax and 345,000 455,000

depreciation

Depreciation is to be charge on straight line basis.

You are required to:

1: calculate the discounted payback period, net present value and internal rate of return for each machine.

2: advise the management of P ltd as to which machine they should take up.

ANSWERS: [NPV: M1=86,909; M2=1,18,074] [IRR: M1=15.46%; M2=14.74%] [payback period:

M1=4.49 YRS; M2=5.41 YRS]

Q11: One out of three mutually exclusive plants A, B and C have to be purchased. The plants are
reported to cost 200,000 each and have an estimated life of 5 years, 4 years and 3 years respectively and
have no salvage value. The company’s rate of return is 10%. The anticipated cash inflows after taxes are
the 3 plants are as follows:

Year Plant A Plant B Plant C

1 50,000 80,000 1,00,000

2 50,000 80,000 1,00,000

3 50,000 80,000 10,000

4 50,000 30,000 _

5 1,90,000 _ _

Find out payback, average rate of return, NPV and profitability index.

Answers [NPV: A=76,440; B=19,370; C=18,990] [payback period: A=4 YRS; B=2.5 YRS; C=2 YRS]
[PI: A=1.3822; B=1.0968; C=0.905] [ARR: A=55.288%; B=54.843%; C=60.336%]

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