Financial Management Assignment (2)
Capital Budgeting Decisions
1. Easy Ltd is evaluating two mutually exclusive proposals for new capital investment.
The company’s cost of capital is 10% and tax rate is 50%. Advice the company as to
which proposal would be profitable using NPV & PI Techniques. The following
information about the proposal are available:
Particular Proposal A Proposal B
Investment Cost 80,000 100,000
Economic Life 4 years 5 years
Earnings before Depreciation and Tax
1st Year 24000 28000
nd
2 Year 28000 32000
3rd Year 32000 36000
th
4 Year 44000 44000
th
5 Year 4000
2. Meenakshi Mills Ltd is considering the purchase of a new machine which will carry
out some operations which are at present performed by Labour. X and Y are two
alternative models and following information are available:
Particular Machine A Machine B
Investment Cost 15,000 24,000
Economic Life 5 years 6 years
Estimated Saving in Scrap p.a. 1000 1500
Estimated Savings in Direct Wages p.a. 9000 12000
Estimated in cost of indirect wages p.a. 600 800
Add. Cost of Maintenance p.a. 700 1100
Additional cost of supervision p.a. 1200 1600
Depreciation will be charged on straightline basis. A tax rate of 50% is assumed.
Evaluate the alternatives according to:
(a) Pay Back Method (b) Unadjusted return on average investment method (c) NPV
Index Method considering cost of capital 8%
3. If the expected rate of return is 30%, do you recommend the following projects?
Particulars Project A Project B
Capital Cost 1 Lakh 1.5 Lakhs
Earnings of the projects
are:
1 30000 50000
2 30000 70000
3 40000 80000
4 50000 50000
4. X ltd has currently under examination a project. Cost of the machinery to be installed
works out to Rs 2 lakhs and the machine is to be depreciated at 20% WDV Method.
Income tax rate is 50%. If the average cost of raising capital is 11%, would you
Page 1 of 2
recommend accepting the project under IRR Method if it gets the following yield over
the period of time:
Year Gross Yield
1 80000
2 80000
3 90000
4 90000
5 75000
5. A project costs Rs 25,000 and has a scrap value of Rs5000 after 5 years. The net
profits before depreciation and taxes for the 5 years are expected to be 5,000/-, 6,000/-
, 7000/-, 8000/- and 10,000/-. Calculate ARR of the project.
6. A project costs Rs 120,000 is expected to yield total earnings after depreciation and
tax of 60000/- over 3 years. The scrap value of the project after 3 years has been
calculated at Rs. 20000/-. Calculate ARR of the project.
7. A project costs Rs 15000/- and has a scrap value of Rs 3000/-. Its stream of income
before depreciation and tax during first 5 years is Rs 3000, Rs 3600, Rs 4200, Rs
4800 and Rs 6000. Assuming Tax Rate at 50% and depreciation on straightline basis,
calculate ARR.
8. There are two projects X and Y. Each involves and invest of Rs 40000. If the Risk free
cut off rate is 10% suggest which of the two projects should be preferred if they
expect the following returns:
Year Project X Project Y
Cash Inflow Certainty Coe. Cash Inflow Certainty Coe.
1 25000 0.8 20000 0.9
2 20000 0.7 30000 0.8
3 20000 0.9 20000 0.7
9. The Amithabh Corporation which has 50% tax rate and a 10% cost of capital (after
tax) is evaluating a project which will cost Rs 1lakh and will require an increase in the
level of inventories and receivables of Rs 50,000/- over its effective life. The project
will generate additional sales of Rs 1 lakh and will require cash expenses of Rs
30000/- in each year of its 5-year life. It will be depreciated on straight line basis. Is
the project acceptable on NPV Criterion.
10. A company is considering a proposal to purchase a new machinery which would
involve a cash outlay 5lakhs and working capital of Rs 60,000/-. The expected life of
the project is 5 years without salvage value. Assume that the company is allowed to
charge depreciation on straight line basis for income tax. If the tax rate is 35% and the
opportunity cost capital is 10%. The expected cash inflows are:
Year 1 2 3 4 5
Cash Inflows 180000 220000 190000 170000 140000
You are required to calculate Pay-back Period, NPV, Discounted Pay Back Period &
IRR. (Note: Working Capital 60,000/- added as the cost of machinery in the
calculation of PBP & in all other methods 60,000 should be added to Cashinflow of
the 5th year).
Page 2 of 2
