MODULE 4 INVESTMENT DECISIONS (CAPITAL BUDGETING)

1. A project costs Rs.1,00,000 and yields an annual cash inflow of Rs.20,000 for 8 years.
Calculate its pay-back period.

2. Determine the pay-back period for a project which requires a cash outlay of Rs.10,000
and generates cash inflows of Rs.2,000, Rs.4,000, Rs.3,000 and Rs. 2,000 in the first,
second, third and fourth years respectively.

3. A project costs Rs.5,00,000 and yields annually a profit of Rs.80,000 after

depreciation @12%p.a. but before tax of 50%. Calculate the pay back period.

4. There are two projects X and Y. Each project requires an investment of Rs.20,000 and
earns the following net profit before depreciation and after tax. You are required to
rank these projects according to the pay back method
Years Project X (Rs.) Project Y (Rs.)
1st 1,000 2,000
2nd 2,000 4,000
3 rd 4,000 6,000
4th 5,000 8,000
5 th 8,000 ─
5. Mohan and Co. is considering the purchase of a machine.two machines X and Y each
costing Rs. 50,000 are available. Cash inflows are expected to be as under. Calculate
payback period.
Year Machine X Machine Y
1 15,000 5,000
2 20,000 15,000
3 25,000 20,000
4 15,000 30,000
5 10,000 20,000
6. Bhagawat Electronics Ltd. is planning to introduce mechanization to replace the
labour force. Two alternatives are available. Advise the management to select the
machine under payback period method.
Machine X Machine Y
Cost of the machine 50,000 40,000
Estimated life of the machine 10 years 8 years
Estimated scrap savings per year 1,000 1,000
Estimated cost of materials p.a. 2,000 3,000
Maintenance cost p.a. 2,500 3,100
Additional cost of supervision 1,500 2,000
Estimated savings in wages 10,000 12,500
Depreciation will be taken on straight line basis. Assume tax rate 50%.

7. For each of the following projects compute (i) pay-back period, (ii) post-back
profitability and (iii) post-back profitability index:
Project A:
Initial outlay Rs.50,000
Annual Cash Inflow (After tax but before depreciation) Rs.10,000
Estimated Life 8 years
Project B:
 Initial Outlay Rs.50,000
Annual Cash Inflow (After tax but before depreciation):
First Three Years Rs.15,000
Next Five Years Rs.5,000
Estimated Life 8years
Salvage Rs.8,000

8. Calculate discounted pay-back period from the following information:

Cost of Project Rs.6,00,000
Life of the Project 5 years
Annual Cash Inflow Rs.2,00,000
Cut off Rate 10%

Average Rate of Return

9. Determine the accounting rate of return from the following two machines X and Y.
Particulars Machine X Machine Y
Original cost 56,125 56,125
Additional investment in working capital 5,000 6,000
Estimated life in years 5 years 5 years
Estimated salvaged value 3,000 3,000
Income tax 55% 55%
Annual estimated income after depreciation Machine X Macine Y
and tax:
1st year 3,375 11,375
2nd year 5,375 9,375
3rd year 7,375 7,375
th
4 year 9,375 5,375
5th year 11,375 3,375
Total 36,875 36,875
Depreciation has been charged on straight line basis.

10. Calculate the average rate of return for projects A and B from the following:
Project A Project B
Investments Rs. 30,000 Rs. 40,000
Expected life 5 years 6 years
Project net income after depreciation and taxes:
Years Project A Project B
1 3,000 6,000
2 3,000 6,000
3 3,000 5,000
4 2,000 3,000
5 1,000 2,000
6 ------- 1,000
Total 12,000 23,000
If the required rate of return is 10%, which project should be undertaken.

11. X Ltd. is considering the purchase of a machine. Two machines are available E and F.
the cost of each machine is Rs. 60,000. Each machine has an expected life of 5 years.
Net profits before tax and after depreciation during the expected life of the machines
are given below.
 Year Machine E Machine F
1 15,000 5,000
2 20,000 15,000
3 25,000 20,000
4 15,000 30,000
5 10,000 20,000
Total 85,000 90.000
Following the method of average rate of return on average investment, ascertain
which of the alternatives will be more profitable. Average tax rate is 50%.

12. Calculate the average rate of return for projects A and B from the following:
Project A Project B
Investment Rs.20,000 Rs.30,000
Expected Life (no salvage value) 4 years 5 years
Projected Net Income (after interest, depreciation and tax):
Years Project A(Rs.) Project B(Rs.)
1 2,000 3,000
2 1,500 3,000
3 1,500 2,000
4 1,000 1,000
5 ─ 1,000
Net Present Value
13. From the following information calculate the net present value of the two projects and
suggest which of the two projects should be accepted assuming a discount rate of
10%.
Project X Project Y
Initial Investment Rs.20,000 Rs.30,000
Estimated Life 5 years 5 years
Scrap Value Rs.1,000 Rs.2,000
The profits before depreciation and after taxes (cash flows) are as follows:
Year 1 Rs.5,000 Rs.20,000
Year 2 Rs.10,000 Rs.10,000
Year 3 Rs.10,000 Rs.5,000
Year 4 Rs.3,000 Rs.3,000
Year 5 Rs.2,000 Rs.2,000

14. No project is acceptable unless the yield is 10%. Cash inflows of a certain project
along with cash outflows are given below:
Years Outflows (Rs) Inflows (Rs)
0 1,50,000 ─
1 30,000 20,000
2 30,000
3 60,000
4 80,000
5 30,000
th
The salvage value at the end of 5 year is Rs.40,000. Calculate net present value.

Internal Rate of Return

15. Initial Outlay Rs.50,000
Life of the Asset 5 years
Estimated annual Cash-flow Rs.12,500
Calculate the internal rate of return.

16. An Equipment involves an initial investment of Rs. 6,000. The annual cash flow is
estimated at Rs. 2,000 for 5 years. Calculate IRR.

17. A project costs Rs. 16,000 and is expected to generate cash inflows of Rs. 4,000 each
for 5 years. Calcus. 6,000 respectively. Calculate IRR.

Profitability Index
18. A project requires an investment of Rs. 10,000 and the expected cash flows are:
Year Cash Inflow PVIF@ 10% Present Value
1 12,000 0.909 10,908
2 4,000 0.826 3,304
14,212
Cost of capital is 10%. Compute profitability index.

19. The initial cash outlay of a project is Rs.50,000 and it generates cash inflows of
Rs.20,000, Rs.15,000, Rs.25,000 and Rs.10,000 in four years. Using present value
index method, appraise profitability of the proposed investment assuming 10% rate of
discount.

20. A company is considering an investment proposal involving an initial cash outlay of

Rs.20,00,000. The proposal has an expected life of 7 years and zero salvage value. At
a required rate of return of 12%, the proposal has a profitability index of 1.182.
Calculate the annual cash inflows. The present value of an annuity of Re.1 for 7 years
at 12% discount is 4.5638.

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