PBP on uneven cash flows

• Calculate PBP if a company requires an

investment of Rs.1200000. The life of the
project is 5 years and the cost of capital is
12%. The salvage value is Rs.200000. The
estimated cash flows before taxes are
Years 1 2 3 4 5
CFBT 200000 220000 250000 300000
325000
 Solution for PBP for uneven cash flows
Years CFBT Dep NPBT Tax NPAT CFAT CCFAT
1 200000 200000 0 0 0 200000 200000
2 220000 200000 20000 10000 10000 210000 410000
3 250000 200000 50000 25000 25000 225000 635000
4 300000 200000 100000 50000 50000 250000 885000
5 450000 200000 250000 125000 125000 325000 1210000
1200000 – 885000 = Rs.315000
325000 - 12
315000 - ?
315000/325000 x 12 = 11.63

PBP = 4.11 years

If 4.11 years is less than predetermined PBP accept the proposal else reject the
proposal
Depreciation = cost of the asset – salvage value /
estimated life of the asset = 1200000 – 200000
/ 5 = Rs.200000
 Accounting or average rate of return

ARR = Average annual net profit after taxes /

Average investment x 100
Average investment = ½ (initial investment –
salvage value) + salvage value + additional
working capital
If ARR is > k accept the proposal
If ARR is < k reject the proposal
 Q on ARR (Even cash flows)
• The initial outlay is Rs.250000, cost of capital
is 10%, salvage value Rs.50000, additional
working capital Rs.10000. The profits before
tax each year is Rs.60000. the estimated life of
the asset is 5 years.
 Solution ARR
• Average investment = ½ (initial investment – salvage value) +
salvage value + additional working capital = 1/2 (250000 –
50000 ) + 50000 + 10000 =  ½ (200000) + 60000 = 100000 +
60000 = Rs.160000
• NPBT60000
• Less: Tax (50%) 30000
• NPAT 30000
• 30000 x 5 = 150000 / 5 = Rs.30000
• ARR = Average annual net profit after taxes / Average
investment x 100 = 30000 /  160000 x 100 = 18.75%
• As ARR(18.75%) is > k (10%) accept the proposal 
 NPV even cash flows
• The initial outlay is Rs.250000, cost of capital
is 10%, salvage value Rs.50000, additional
working capital Rs.10000. The profits before
tax each year is Rs.60000. the estimated life of
the asset is 5 years. Calculate NPV
 Solution NPV even flows
• NPBT 60000
• Less: Tax (50%) 30000
• NPAT 30000
• Add Depreciation 40000
• CFAT 70000
• NPV = PVCI – PVCO =
• 302560 – 260000 = Rs.42560
• PVCI = CFAT X Annuity factor + Salvage value x PV factor + additional working capital x PV
factor =
• 70000 x 3.79 + 50000 x 0.621 + 10000 x 0.621 =
• 265300 + 31050 + 6210 =
• 302560
• Pvco = initial investment + Additional working capital =
• 250000 +10000 = Rs.260000
• Depreciation = cost of the asset – salvage value / estimated life of the asset = 250000 – 50000
/ 5 = 200000 / 5 = Rs.40000
• As Npv is > 0 accept the proposal
 NPV Uneven cash flows
• The cost of the asset is Rs.200000, cost of
capital is 12%, salvage value nil, additional
working capital Rs.6000. The estimated life of
the asset is 4 years. Tax rate 20%. The cash
flows before taxes every year are as follows
• Years 1 2 3 4
• CFBT 85000 100000 120000 150000
• (in Rs.)
Years CFBT DEP NPBT TAX NPAT CFAT
1 85000 50000 35000 7000 28000 78000
2 100000 50000 50000 10000 40000 90000
3 120000 50000     70000    14000   56000       106000
4 150000 50000     100000   20000   80000      130000
4 6000

PV factor @10% PVCI@10%

4 0.893  69654
5 0.797  71730
6 0.712  75472
7 0.635  82550
8 0.635 3810
PVCI 303216
Less: PVCO 206000
NPV 97216
PVCO = Initial investment + additional working capital = 200000 + 60000 = Rs.206000
As NPV is >0 accept the proposal
PI = PVCI / PVCO = 303216 / 206000 = 1.47
As PI is > 1 accept the proposal
• Profitability index (PI) = PVCI / PVCO
• If PI is > 1 accept the proposal
• If PI <1 reject the proposal