(B

NI/ PI/MNI
NTPT Tohl faeset vale ar cIF
Tadnl Py. CoF

NINT- NPY
Fuiliad cash ord hou
COF)
NI resect Valse mde
PI oitaal Tndex
NPVI- Nt Pruec Valve dex

CIRR
| Sdep-I .v. Focar > Mitial Twekmek
Aveate cIF AN cIF
SteP-T TRR LOR + - I (HoR-L9R)
P- P2
LOR Lower Disont Rake
HOR ther
P Pv. LOR
Pv at h9R

T Net cash oudbuw CoF)

3,31
EsP? 42, 13, 21,

us
fo
3
E
Illustration 24 : 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 fir_t four years. Using present value inde
method, appraise profitability of proposed investment assuming 10% rate of discount.
The present value of Re. 1 at 10% discount factor fot four years is.909, .826, .751 and 683
Solution
Calculation of Present Value and Profitability Index-
Year Cash Inflows PVfactor at 10% Present Vatue
Rs. Rs.
20,000 909 18,180
15,000 826 12,390
25,000 .751 18,775
4 10,000 683 6,830
Total 56,175
Net Present Value =
Total Present Value Initial Outlay
Rs. 56,175 Rs. 50,000 Rs. 6,175
Present Value of Cash Inflows
Profitability Index or PVI =

Initial Cash Outflows

Rs. 56,175
Rs. 50,000 1.1235
As profitability index is more than 1, the
proposal can be accepted.
Net Present Value
Net Profitability Or NPVI =

Initial Cash Outflows

Rs. 6,175 =
.1235
Rs. 50,000
Or NPI1.1235 1 0.1235
Asnet profitability index is positive, the
proposal may be accepted.
ilustration 29 Pick up Limited desires to purchase a new machine in order to increase its
present level of production. The cost of machine will be Rs. 70,000 and the net cash inflows durine
its life will be as follows
Year 1 2 3 4 5
Net Cashflows (Rs.) 50,000 40,000 20,000 10,000 10,000
Minimum rate of return laid down by the management is 25%
p.a. Is the investment des.rable?
Discuss it according to Internal Rate of Return.
Discount Factor
Year 1 2 3 A 5
35% .741 .549 406 .301 223
40% .714 .510 .364 .260 .186
Solution
Verification of First Trial of Return
Year Cash Inflows PV Factor at 35% Present Value
Rs.
Rs.
50,000 741
40,000 37,050
549 21,960
20,000 406
10,000 8,120
.301 3,010
10,000
223
2,230
The present value of cash inflows (Rs. 72,370
72,370) at
f investment (Rs.
70,000), hence next trial will be 35% discount
cost
factor is more than
Tywwant valhac would be is as under- at the
higher rate i.e. at 40% at wn the
 Verification of Second Trial Rate of Return
Year Cash Inflows PV Factor at 40% Present Value
Rs. Rs.
50,000 .714 35,700
40,000 510 20,400
20,000 364 7,280
10,000 260 2,600
5 10,000 .186 1,860
67,840
The present value of cash inflows at this rate (40%) of return is Rs. 67,840 which is less than
the cost of investment (Rs. 70,000), hence the IRR will be less than 40%. The actual IRR lies
between 35% and 40% which will be calculated by simple interpolation as under

IRR LDR + P x
(HDR -

LDR)
Where:LDR=Lower Discount Rate
P,
P Present values at lower rate of interest
Present values at higher rate of interest
P Net Cash Outlay
=
HDR Higher Discount Rate

Substituting the values,

Rs. 72,370 70,000 (40 35)
IRR35 Rs. 72.370 67,840 X

2370 5
35* 4.530
3 5 + 1 , 8 5 0

4,530
= 352.62 37.62%

Decision: As such, the total present value of cash inflows of five years will be equai to the
investment at 37.62% rate of return. In the question, this rate is more than the minimum
desired rate of retum (37o) 1xea by the management. Therefore, the project should be accepted

. In order to make a deision On +h

lhustration 30: Bright Metals Ltd. are considering two different investment proposals. The details
areas under
Proposal - B
Proposal-A
Rs. Rs.
Investment Cost 9,500 20,000
Estimated Cash inflows at the end of
Year I
4,000 8,000
Year II
4,000 8,000
Year III 4,500 12,000
a) Suggest the most attractive proposal on the basis of Excess Present Value Method considering
future cash inflows are discounted at 12%.
(6) Also find out the Internal Rate of Return of the two proposals.
The present value of Re. 1 receivable at the end of each period on various rates of discount are:
Year 10% 12% 14% 15% 16% 17% 18%
9091 8929 8772 8696 8621 8547 8475
8265 7972 .7695 .7561 .7432 7305 .7182
3 .7513 .7118 .6750 6575 6407 6244 6086
Solution
(a)Net Present Value Method
Year Discount Proposal-A Proposal-B
factor at 12% Cash Inflows PV of Cash Inflows Cash Inflows P.V of Cash Inflows
Rs. Rs. Rs. Rs.
0.8929 4,000 3,572 8,000 7,143
0.7972 4,000 3,189 8,000 6,378
0.7118 4,500 3,203 12,000 8,542
Total Present Value 9,964 22,063
Less : Initial Investment| 9,500 20,000
Net Present Value 464
2,063
Most attractive proposal B, because N.P.V is higher in case ofB.
(b) Internal Rate of Return Method

Proposal-4 Present Value Discounting Present Value

Year Cash Inflow Discounting factor at 15%
factor at 14%
Rs. Rs.
Rs 8696 3,478
8772 3,509
4,000 .7561 3,024
4,000 .7695 3,078
4.500 6750 3,038 .6575 2,959
Total 12,500 9,625 9,461
Less: Investment 9,500 9,500
N.P.V. 125 39
IRR must be betwcen 14% and 15%. We can find out actual I.R.R. by way of interpolation as

follows
IRR LDR+ x (HDR - LDR)
*P-P2
14R
4 Rs.9,6259,500x
Rs. 9,625 9,461 (15 - 14)
14 + AX 1
164
=
14 + .76 14.76% IRR of Proposal-A
Proposal--B
Year Cush Inflow Discounting Present Value Present Value
Rs. factor at 17%
Discounting
Rs. factor at 18% Rs.
8,000 8547 6,838 8475 6,780
8,000 .7305 5,844 .7182 5,746
12,000 6244
Total
1,493 .6086 7,303
28,000
Less: Investment
20,175 19,829
20,000 20,000
N.P.V.
175 171
IRR must be between 17% and 18%.

IRR LDR+ 0 x
(HDR- LDR)
=17+ KS. 20,175 - 20.000
Rs. 20,175 -19.829 *
(18 17)
17+175
346 *1
=
17 +.5 =17.5% IRR of
/ Decision: Most atiractive
proposal is B. Proposal-B
itation 31 A company has to select one of
the
following two projects
Proposal A Proposal-
Cost Rs. Rs
11,000 10,000
 Cash inflows

Year
6,000 1,000
Year 2
2,000 1,000
Year 3
1,000 2,000
Year 4 10,000
5,000
Tlsing the internal rate of return method suggest which
project is preferable.
s u n t Factor

Year 2
10% 909 826 .751 683
12% 893 797 .712 636
15% 870 .756 658 572
Solation
Factor in case of Project A = 011,000 = 3.14 10,000 = 2.86
3,500 Project B 3,500
In case of Project A, the rate comes to 10% while in case of Project B it comes to 15%.

Project-A Present Value

lkar Cash Infow Discounting Present Value Discounting
Rs. Jactor at 10% Rs. factor at 12% Rs.

6,000 .909 5,454 .893 5,358

.826 i,652 797 1,594
2,000
.751 751 .712 712
1,000
3,415 .636 3,180
5,000 683
otal 11,272 10,844
14,000
iess: Investment 11,000 11,000
272 156
NPV.
The exact rate may be calculated as follows:
IRR is thus more than 10% but less than 12%.

IRR LDR+ (HDR -

LDR)

Rs. 11,272-11,000 (12. 10)

(12
10 Rs. 11,272 10,844

10 272 2
428
= 10+ 1.27 11.27

Project-B
rar Present Value Discounting Present Value
Cash Inflow Discounting
Rs. factor at 15% Rs
factor at 10%
Rs. 909 870 870
1,000 909 826 756 756
1,000 826
1,502 658 1,316
2,000 .751
,683
6,830 572 5,720
10,000 10,067 8,662
14,000 10,000 10,000
avestment 67 1338
 Present value at 10% and 15% comes to Rs. 10,067 and Rs. 8,662 respectively. So lower rate
rate
of discount should be taken.

IRR LDR + P-0 (HDR - LDR)

P-P2
10,067 10.000
= 10 +Rs. x (15 -

10)
Rs. 10,067 8,662
67
10+1405 x5
= 10+.238 10.24%
Decision: Thus, IRR in of Project
A is preferable.
case A is higher as compared to Project B. Hence, Project
Hastration 40 Sanjay Mills Ltd. is considering the purchase of a new machine which will cary
ome operations which are at present performed by labour. X and Y are alternative models. The
ollowing informations are available :
Machine X Machine Y
Rs. Rs.
Cost of Machine 15,000 24,000
5 years 6 years
Estimated life of machine
 Estimated saving in scrap p.a. 1,000
Estimated cost of indirect materials p.a. 600
1,500
800
Estimated savings in direct wages p.a. 9,000 12,000
Additional cost of maintenance p.a. 700
1,100
Additional cost of supervision p.a. 1,200 1,600
Depreciation will be charged on a straight-line basis. A tax rate of 50% 15 assumed.
Evaluate the alternatives according to:
(a) The pay-back method;
(b) Unadjusted return on average investment method; and
(c) Net present value index method (cost of cpaital 8 percent)
Note : The present value of Re. 1@ 8% per annum received annually for 5 years is 3.993 and
for 6 years is 4.623.
Solution
Profitability Statement
MachineX Machine Y
Savings per annum Rs. Rs.
Wages 9,000 12,000
Scrap 1,000 1,500
Gross Saving (A) 10,000 13,500
Additional Cash Cost per annum
Indirect materials 600 800
Maintenance 700 1,100
Supervision 1,200 1,600
Total Cash Costs (B) 2,500 3,500
Cash Savings p.a. (A B) 7,500 10,000
Less: Depreciation (straight line) 3,000 4,000
Annual Savings p.a. (before tax) 4,500 6,000
Less: Income tax @ 50% 3,000
2,250
Annual Savings p.a. (after tax) 2,250 3,000

Add: Depreciation 3,000

4,000

Annual Cash Inflows 5,250 7,000

Evaluation of Projects
) Pay-back Method
Initial Investment
(a) Pay-back Period Annual Cash Inflows
Machine X =
Rs. 15,000
Rs. 5,250 2.86 years

Machine Y Rs. 24,000 3.43 years

Rs. 7,000
(b) Post Pay-back Profitability Annual Cash Inflows x
(Whole life -

Pay-back pe
iod)

Machine X Rs. 5,250 x (5-2.86) Rs. 11,235

Machine Y Rs. 7,000x (6-3.43) Rs. 17,990
 ecision: According to Pay-back
Deci

profitability method is used,period

stpay-baack profitabilit method, the
then machine Y machine X should be purchased, Dut if
i
Return on Average should be purchased.
purchased.
Cnadjusted.

Investment Method
Average
Rate of Return =
Average Annual Net
Average InvestmentSavings x 100
Machine X Rs. 2,250
Rs. 7 , 5 0 0 * 100 = 30%

MachineY Rs. 3,000

Rs. 12,000 100 25%
Average Investment =
Initial Investment/2
Decision According to this method machine X
Net Present Value Index Method: should be purchase.
Present Value Annual Cash Inflows x P. V. Factor
at 8%
Machine X Rs. 5,250x 3.993
Rs. 20,963
Machine Y Rs. 7,000 x 4.623 Rs. 32,361
Net Present Value Present Value
Index
Investment
Rs. 20,963
Machine X Rs. 15,0001.3975 Machine Y
Rs. 32,361
1.3484
Rs.
Rs. 24,000
Decision: According to this method also, the machine Xshould be purchased.
ilastration 41: The following details relates to the two machines X and Y:
MachineX Machine Y
Cost Rs. 56,125 Rs. 56,125
Estimated Life 5 years 5 years
Estimated salvage value Rs. 3,000 Rs. 3,000
Annual incomce after tax and depreciation .

Year Rs Rs.
I 3,375 11,375
II 5,375 9,375
II 7,375 7,375
IV 9,375 5,375
V 11,375 3,375
Overhauling charges at the end of third year KS. 25,000 on machine Y. Depreciation has
Discount rate is 10%, P.V.E. at 10% for five years
arged at straight line method. are
,0.826, 0.751, 0.683 and 0.621
Suggest which project should be accepted.
lution
n Culationof Present Value of Cash-outflows:
Present Value
Investnent
P.V Factor at 10% X
Rs. Rs. Rs.
KS. 1.000 56,125 $6,125
S6.125 56,125
25,000 0.751 18,775
56,125 74,900
i) Calculation of Cash lnflows :
MachineY
Machine X

Year Income | Depreciation| Cash InflowsAnnual Income DepreciationCash Inflo

Annual Rs. Rs.
Rs. Rs. Rs.
Rs.
14,000 11,375 10,625 22,000
3,375 10,625
16,000 9,375 10,625 20,000
II 5,375 10,625
18,000 7,375 10,625 18,000
III 7,375 10,625
20,000 5,375 10,625 16,000
IV 9,375 10,625
10,625 22,000 3,375 10,625 14,000
11,375
(i) Calculation of Present Value of Cash Inflows:
Present Value
Cash Inflows
PV Factor Machines
Machines
Y at 10% X
Year X
Rs. Rs. Rs. Rs.

14,000 22,000 0.909 12,726 19,998

16,000 20,000 0.826 13,216 16,520
18,000 18,000 0.751 13,518 13.518
20,000 16,000 0.683 13,660 10,928
22,000 14,000 0.621 15,525 10,557
3,000* 3,000
Total Present Value 68,645 71,521
Salvage value at the end of life of the machines.
Net Present Value = P.V. of Cash Inflows- P.V. of Cash Outflows

Machine X Rs. 68,645

=

Rs.
56,125 Rs. 12,520
Rs. 71,521 Rs. 74,900 Rs.13,379
Machine Y
Decsion: Machine X should be selected
Note: Overhauling charges is capital expenditure but it does not increase the capacity.
llustration 42 X Ltd. is contemplating adding a new product line.The new product line wou
be marketable for only five years, after which time it would have to be discontinued. The cosi
and revenues that would be associated with the new line are

Rs.
Cost of equipment required
Working Capital needed 80,000
Salvage value of equipment in 5 years 70,000
Annual sales revenues 10,000
75,000
Annual out of pocket costs for salaries, advertising etc. 45,000
Overhaul of the equipment required in 4 years. 5,000
The company's cost ot capital is 12%. Would you be
introduced. Ignore income tax. recommended that the new n
The Present value or Ke. 1 10r S years at 12% discount .567.
factor is .893, .797,.712,630 a
s0ioa
Computation of Present Value of Cash
Outflows
Cost o f E q u i p m e n t Rs
Working Capital needed 80,000
erhauling of Equipment in 4th year 70,000
(Rs. 5,000 x
0.636) 3,180
1,53,180
Computation of Present Value of Cash Inflows
Cash Inflows P.V Factor Present Value
Rs. at 12% Rs.
30,000 893 26,790
30,000 .797 23,910
30,000 .712 21,360
30,000 636 19,080
1,10,000* 567 62,370
1,53,5100
Tis includes Rs. 70,000 for released Working Capital and Rs. 10,000 for salvage value.
Net Present Value Rs. 1,53,510 Rs. 1,53,180 Rs. 330
Net Present Value is Rs. 330; hence new line may be introduced.
ring Notes
Annual Cash Inflows Rs.
Annual Sales Revenues 75,000
Less: Annual out of pocket cash for salaries, adv. etc. 45,000
30,0000

ncome tax-ighóred in absence of information.

The following the
43 : X Co. Ltd. is considering two mutual exclusive projecis.
strationn 43: are

Romation for the same. Rs. 20,0000

Initial Investment 5 years
Life time of the Project 10%
Required Rate of Return 50%
Tax Rate
The Net cas before tax and depreciation are
nflows 3
2
Year 1 8,000 8,000 8,000
8,000
Project A Rs. 8,000
8,000 4,000 10,000 10,000
Project B Rs. 10,000
line You are required to caleulate:
method.
The project
( ject will be depreciated
on straight
index for each project.
() The net present
p value and profitability
(Gi) Tnet
ti) wLemal
The interm: rate of for each project.
return
and why?
Which project
COunt Factor should be accepted
18%
ear 10%
15% 16%
847
.870 862
.909 .743 718
.756
.826
 .751 658 641 609
683 572 552 516
621 497 476 431
Total 3.790 3.353 3.274 3.121
Solution
Calculation of Cash Inflows after tax
Project B
Project A
Particualrs Equal for I Yr. II Yr. III Yr. IV Yr.VY
each year
Rs. Rs. Rs. Rs. Rs. Rs.
Cash Inflows before taxes and dep. 8,000 10,000 8,000 4,000 10,000 10,000
Less: Depreciation 4,000 4,0004,000 4,000 4,000 4,000
Income before tax 4,000 6,000 4,000 6,000 6,000
Less: Tax@50% 2,000 3,000 2,000 3,000 3,000
Net Income 2,000 3,000 2,000 3,000 3,000
Add: Depreciation 4,000 4,000 4,000 4,000 4,000 4,000
Net Cash Inflows 6,000 7,000 6,000 4,000 7,000 7.000
Cummulative Cash Inflows 7,000 13,000 17,000 24,000 31,000
(i) Net Present Value and Profitability Index
Calculation of Net Present Value
Year Cash Inflows P.V Factor Present Value
Project A Project B at 10% Project A Project B
Rs. Rs. Rs. Rs.
6,000 7,000 909 5,454 6,363
6,000 6,000 826 4,956 4,956
6,000 4,000 751 4,506 3,004
6,000 7,000 683 4,098 4,781
6,000 7,000 621 3,726 4,347
Total Present Value
22,740 23,451
Net Present Value Total Present Value Initial Investment
Project A =
Rs. 22,740 Rs. 20,000 Rs.
2,740
Project B Rs. 23,451 Rs. 20,000 Rs. 3,451
-

Profitability Index = Present Value of Cash Inflows

Present Value of Cash Outflows
Project A Rs. 22,740
Rs. 20,000 1.137 Project B Rs. 25,4S- 1.173
Rs. 20,00o
(iv) Intermal Rate of Return
Project A
The amount of cash intlows for each year from this project is hence, first
o.

factoror pay-back period will be calculated even, ora

P.V.Factor Rs.Rs.20,000
6,000 3.33
 In
the 5th year row of the cumulative
the Sth

pier)
the rate of retum at this p.v. factor is present
15%. The
value table (Table given at the end of this
B given
1352 which is more
3.352 which than 3.333. cumulative present valuc factor at this D
IRR is calculated using interpolationHence, the actual
IRR must lie between
betwecen 15% and 16%
15e and
PV. at 15%= Rs. 6,000 3.352 Rs. 20,112
x technique as under
pV. at 16% Rs. 6,000 x
3.274 Rs.
19,644
IRR LDR+ x (HDR LDR)
Where:LDR =
Lower Discount Xate
Present values at lower rate of
interest
Present values at
Net Cash Outlay
higher rate of interest
HDR Higher Discount Rate
Substituting the values,
IRR =15+S. 20,112-20,000 x (16 15)
Rs. 20,112 19,644
=15+ 2 1
468
+0.24 15.24%
=
15
roject B
Cash inflows are uneven, hence trial and error method will be used. The P.V. factor for this
been calculated as under-
P.V. Factor = Initial Investment
Average Annual Cash Inflows
Rs. 20,000 Rs. 20,000
Rs. 31,000/5 Rs. 6,200.23
n the Sth year row of cumulative present value table, the rate of return at this pv. factor
25) is 18% approximately. Hence, the present value of cash inflows for various years at this rate of
will be computed and then compared with the cost of the project
Present Value at Different Trial Rates

Cash Inflows TrialNo. Trial No. 2

Rs. PK Factor PV PK Factor P
at 18% Rs. ar 16% Rs
7,000 847 5,929 862 6,034
718 4,308 .743
6,000 4,458
609 2,436 641
4,000 2,564
516 3,612 552
7,000 3,864
.431 3,017 476
7,000 3,332
Total Present Value 19,302 20,252
19.302) of cash inflows at 18% rate of retum is less than
Do ne total
o the
present value (Rs.
proiect, hence next lower trial rate T0% 1S chosen. The present value of cash
s ,20,252)at thís rate is more than the coSt O CProject. Theretore, the IRR wilt be more
than 16%. The actual IRR lies between 16% and 18% which
would be calculated using sima
interpolation as under
simple
-Q
IRR LDR+P-P2x x (HDR -

LDR)

Rs. 20,252- 20,000 x (18 16)

16+
Rs. 20,252 19,302
16+ 25 x2
=
16 +0.53 16.53%
Conclusion Project A Project B
) NPV Rs. 2,740 Rs. 3,451
(ii) Profitability Index 1.137 1.173
(ii) IRR 15.24% 16.27%
Decision: In all these methods of project evaluation the selection of project B is profitable
as the value of NPV, PI and IRR all are more than that of
project A. Only pay-back period of
Project A is less, but a little bit of time.