Pondicherry University

Department of Management Studies

Financial Management
Capital Budgeting

1.a) Calculate the initial investment cost of an expansion project if

Cost of machine Rs.10,00,000
Cost of transporting machine 50,000
Other Installation expenses 20,000
Increase in net working capital 60,000
Cost of training personnel 20,000
Initial cost of advertisement 20,000
Tax rate 30%

1.b) A firm has to replace the existing machine. The cost of the new machine, transport, and
installation are respectively Rs.10,00,000, Rs.1,00,000 and Rs.20,000. The old machine
which had been procured for Rs.9,70,000 is sold for Rs.80,000. The accumulated
depreciation is Rs.9,00,000. The increase in net working capital amounts to Rs.1,00,000.
Calculate the initial investment

2) Calculate the operating cash flow if

The first year’s sales are valued at Rs.1,00,000 which is expected to grow at 5% in the second
year but to decline by 1% in the third year. The raw material cost is 40% of the sale value.
The operating cost amounts to 20% of the sale value of which depreciation amounts to
Rs.10,000. The interest amounts to Rs.5,000 p.a. tax rate is 30%.

3)There are two mutually exclusive projects under active consideration of a company. Both
the projects have a life of five years and have initial cash outlays of Rs.1,00,000 each. The
company pays tax rate at 50% rate and the maximum required rate of the company has been
given as 10%. The straight-line method of depreciation will be charged on the projects. The
projects are expected to generate a net cash inflow before taxes as follows
Year Project X Rs Project Y Rs
1 40,000 60,000
2 40,000 30,000
3 40,000 20,000
4 40,000 50,000
5 40,000 50,000

With help of the above given information you are required to calculate
a)The payback period of each project
b) The Average rate of return for the project
On the basis of your calculations advise the company which project it should accept giving
reasons
4) There are two mutually exclusive projects under active consideration of a company. Both
the projects have a life of five years and have initial cash outlays of Rs.1,00,000 each. The
company pays tax rate at 50% rate and the maximum required rate of the company has been
given as 10%. The straight-line method of depreciation will be charged on the projects. The
projects are expected to generate a net cash inflow before taxes as follows
Year Project X Project Y
Rs Rs
1 40,000 60,000
2 40,000 30,000
3 40,000 20,000
4 40,000 50,000
5 40,000 50,000

With help of the above given information you are required to calculate
a) The NPV and Profitability Index for each project
b) The IRR for each project
On the basis of your calculations advise the company which project it should accept giving
reasons

5)Cost of Machinery 8,00,000 Installations Rs.1,00,000, WC increase Rs.1,00,000, Scrap

Value Rs.1,00,000. CFBT 4,00,000, Required rate of return 9% and Tax rate is 30%, Life is 4
years. Find out PBP and ARR.

6) Cost of Machinery 8,00,000 Installations Rs.1,00,000, WC increase Rs.1,00,000, Scrap

Value Rs.1,00,000. CFBT 4,00,000, Required rate of return 9% and Tax rate is 30%, Life is 4
years. Find out NPV and IRR.

7) Rahave Ltd is producing articles mostly by manual labour and is considering to replace it
by a new machine. There are two alternative models X and Y of the new machines. Prepare a
statement of profitability showing the payback period from the following information
Machine X Machine Y
Estimated life of the machine 4 years 5 Years
Cost of machine 1,80,000 3,60,000
Estimated savings in Scrap 10,000 16,000
Estimated savings in direct Wages 1,20,000 1,60,000
Additional cost of Maintenance 16,000 20,000
Additional cost of Supervision 24,000 36,000
8) YN Ltd is considering two alternative projects for investment. The projects are mutually
exclusive. The company wants to choose the best alternative using non-discounted cash flow
techniques. Advice the company with the help of the following details
Particulars Project Y Project N
Cost of the project 10,50,000 12,00,000
Useful life of the Project (Years) 4 5
Estimated Salvage Value at the end of life 50,000 1,00,000
Working capital requirement 2,50,000 3,00,000
Profit After Tax
I Year 1,00,000 2,10,000
II year 2,50,000 4,40,000
III year 4,70,000 5,70,000
IV Year 3,40,000 3,20,000
V year 1,60,000

9) Initial Investment Rs.10,50,000

Operating cash flow
1st Year 4,50,000
2 Year
nd
6,00,000
3 Year
rd
3,00,000
Terminal cash flow Rs.44,500
Discount factor 10%
Find out NPV, PI, IRR and MIRR

10) Two mutually exclusive proposals A and B have following cash flow to be discounted at
10%.
Year Cash flow A Cash flow B
0 -70,000 -84,000
1 30,000 34,000
2 32,000 31,000
3 38,000 26,000
4 - 20,000
5 15,000
6 10,000
Find out which proposal can be accepted by using ANPV and replacement chain method

11) The net cash flow of a project in the first, second and the third year is respectively
Rs.30,000, Rs.32,000, and Rs.35,000. The cash flow is subject to an inflation rate of 3% and
the discount factor of 10% is subject to a 5% inflation rate. Calculate NPV with and without
inflation-adjustment, with a given initial investment for Rs. 50,000.
12) XYZ Global ltd is examining two mutually exclusive proposals, costing Rs. 40,000 and
30,000 respectively. The management of the company uses certainty equivalents (α1)
approach to evaluate new investments proposals. From the following information pertaining
to these projects, advise the company as to which project should be taken up by it.
Proposal X Proposal Y
Year Cash flow Rs. Α Cash flow Rs. α
1 20,000 0.90 15,000 0.95
2 18,000 0.80 12,000 0.80
3 12,000 0.80 10,000 0.75
4 10,000 0.60 5,000 0.70
The risk-free borrowing rate is 8%.

13) From the following particulars, state which project is preferred. Two alternative projects
are available (Project X and Project Y) each costing Rs.10,00,000
Year Project X Rs. Project Y Rs.
1 4,00,000 5,00,000
2 3,50,000 4,00,000
3 2,50,000 3,00,000
4 2,00,000 3,00,000

The company has a target return on capital (riskless discount rate) of 10%. The management
consider risk premium rate 2% and 8% respectively for project X and Y.

14) XYZ company is considering to make investment in a proposal which requires an outlay
of Rs.50,000. The project has a life of three years over which the following cash inflows are
Year 1 Year 2 Year 3
Cash flow Probability Cash flow Probability Cash flow Probability
Rs. Rs. Rs.
10,000 0.10 10,000 0.20 10,000 0.30
20,000 0.20 20,000 0.30 20,000 0.40
30,000 0.30 30,000 0.40 30,000 0.20
40,000 0.40 40,000 0.10 40,000 0.10
likely to be generated:
If the discount rate is 4% and the cash flows of the three years are independent. Determine
the expected NPV.

15) There are two projects X and Y under consideration of the management. The probabilities
of cash flows are as follows
Cash flows Rs.4,000 Rs.8,000 Rs.12,000 Rs.16,000
Probability X 0.2 0.3 0.3 0.2
Probability Y 0.10 0.40 Rs.40 Rs.10
With the help of this information, find out which project is riskier on the basis of standard
deviation and Co-efficient of variation.
16) Bharath Ltd. Has under consideration two mutually exclusive projects X and Y. You are
required to advise the firm about the acceptability of the projects from the following
information using sensitivity analysis.
Project A Project B
Initial investment Rs. 4,00,000 Rs.4,00,000
Estimated cash inflows Worst 60,000 -
Pessimistic 80,000 80,000
Optimistic 1,00,000 1,60,000
Required rate of return 10% 10%
Life of the project 15 years 15 Years

17) X ltd is considering the purchase of a new plant requiring a cash outlay of Rs 20,000. The
plant is expected to have a useful life of 2years without any salvage value. The cash flows
and their associated
probabilities for the two years are as follows:
Year Cash Flow Probability
1 st
8,000 0.3
2 nd
11,000 0.4
3 rd
15,000 0.3
2 year- if cash flows in 1 year are:
nd st

Rs.8,000 Rs.11,000 Rs.15,000

CF Probability CF P CF P
4,000 0.2 13,000 0.3 16,000 0.1
10,000 0.6 15,000 0.4 20,000 0.8
15,000 0.2 16,000 0.3 24,000 0.1
Presuming that 10% is the cost of capital you plot the above date in the form of a decision
tree and suggest whether the project should be taken up or not

18) What are the projects will you choose if the total affordable capital is Rs.20,00,000 using
NPV, IRR and PI based on following information and state capital used and NPV
Project Capital NPV IRR
A 7,00,000 3,00,000 20%
B 2,50,000 1,60,000 17%
C 5,00,000 2,00,000 19%
D 2,00,000 1,00,000 17.5%
E 5,50,000 4,50,000 18%
F 7,50,000 -2,50,000 12%