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CAPITAL BUDGETING
Q No.1 Financial Management Policy

A firm invested cash Rs.200,000 on a project. It is forecasted that following cash flow will generate by
this project in coming 5 years. Firm cost of capital is 12%.

Year Cash Inflow

1 Rs. 50,000
2 50,000
3 75,000
4 125,000
5 75,000

Requried: Use above information to calculate

 Payback period
 Discounted payback period
 NPV
 Profitability Index
 IRR

Q No.2

A company is considering an investment proposal to install new milling machine. The project will cost
Rs.50,000. The facility has a life expectancy of 5 years and no salvage value. The company tax rate is
40%. Firm uses straight-line method for depreciation. The estimated earning before tax from the
proposed investment plan are as under.

Year Earning before tax

1 Rs. 22,000
2 18,000
3 14,000
4 15,000
5 25,000

Compute cash flow for 5 years.

Calculate:
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1. Payback period
2. Profitability Index
3. IRR
4. NPV( discount rate is 15%)

Q.3

Firm purchased plant Rs. 150,000; foundation cost paid 10,000 and installation Rs. 20,000. Estimated life
is five years with zero salvage value. Estimated earning is as follows.

Years EBT
1 Rs. 70,000
2 Rs. 50,000
3 Rs. 70,000
4 Rs. 70,000
5 Rs. 60,000

Firm uses Straight Line Method. Tax rate 40% and cost of capital is 15%.
Calculate:
(i) Payback period
(ii) Profitibility Index
(iii) NPV
(iv) IRR

Q.4 Firm purchased plant Rs. 150,000; foundation cost paid 10,000 and installation Rs. 20,000. Project is
forecast for five years, details are as follows:

 Sales 15000 units for first year [growth of sales by 20% for next two years and then 10% for rest
of the project life].
 Working capital required at the start of project 10,000.
 Sales price 25 per unit
 Variable cost of sales Rs. 8 per unit
 It is assumed that inflation will be 6% in coming years which will impact on selling price of
product and variable cost.
 Fixed expenses Rs. 10,000(excluding depreciation)

Firm uses diminishing Balance Method [rate20%] and tax rate 40%. Assume that plant sold at the end of
the project at Rs. 50,000. Cost of capital 15%.

Calculate

NPV and IRR

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Q No.5

Lobers Inc, has two investment proposals, which have the following characteristics

Project A
Period Cost Profit after tax Net cash flow
0 9000 ------ -------
1 1000 5000
2 1000 4000
4 1000 3000

Project B

Period Cost Profit after tax Net cash flow

0 12000 ------- --------

1 1000 5000

2 1000 5000

3 4000 8000

For each project, compute its payback period, its net present value, and its IRR using a discount rate of
15%.

Q No.6

The Wingler Equipment Company purchased a machine 5 years ago at a cost of $100,000. It had an
expected life of 10 years at the time of purchase and an expected salvage value of $10,000 at the end of
the 10 years. It is being depreciated by the straight line method toward a salvage value of $10,000.

A new machine can be purchased for $150,000, including installation costs. Over its 5 year life, it will
reduce cash operating expenses by $50,000 per year. Sales are not expected to change. At the end of its
useful life, the machine is estimated to be worthless. Straight line method of depreciation will be used
with no salvage value.

The old machine can be sold today for $65,000. The firm’s tax rate is 34 percent. The appropriate
discount rate is 15 percent.

Required
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1. What is the NPV of this project? Should the firm replace the old machine?

Q No.9

Your feasibility require land which you bought at Rs.1.2 million on October 10, 2005 and you will pay in
December 2005. You plan to construct a building on this land and estimate that 4 million will be paid in
2006 and 4 million will be paid in 2007. Equipment will be required in 2007 and estimated cost for this
equipment will be 10 million.

Project also requires an initial investment in net working capital equal to 12% of the estimated sales in
the first year. This investment will be made in December 2007 and this working capital will also be
required to increase every year by 12% of any sales increase expected during the year. The project
estimated economic life is 6 years. At that time, the land is expected to have a market value of 1.7
million, the building a value of 1.0 million and the equipment a value of 2 million.

Marketing department expect sales for 2008 would be 25000 units and price set for this year is Rs. 2200
per unit. The production department has estimated that variable manufacturing costs would total 65%
of sales value and fixed overhead costs, excluding depreciation would be Rs.8 million for the first year of
operation. Sales prices and fixed overhead costs are expected to increase by 6% per year.

Tax rate is 40%. Assume cash flow will occur at the end of every year. Also assume that company uses
diminishing balance method (rate 15%) for equipment and 5% for building depreciation. Assume cost of
capital 15% to calculate NPV.

Q 10:

ABC Ltd manufactures toys and other short lived fad items. The research and development department
has come up with an item that would make a good promotional gift for office equipment dealers. As a
result of efforts by the sales personnel, the firm has commitments for this product.

To produce the quantity demanded, ABC Ltd will need to buy additional machinery and rent additional
space. It appears that about 25,000 square feet will be needed; 12,500 square feet of presently unused
space, but leased at the rate of Rs.3 per square foot per year, is available. There is another 12,500
square feet adjoining the ABC facility available rent of Rs.4 per square foot.

The equipment will be purchased for Rs.900, 000. It will require Rs.30,000 in modifications, Rs.60,000 for
installation and Rs.90,000 for testing. The equipment will have a salvage value of about Rs.180, 000 at
the end of the third year. No additional general overhead costs are expected to be incurred.

The estimates of revenues and costs for this product for the three years have been developed as
follows:
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Particulars Year 1 Year 2 Year 3

Sales Rs.10,00,000 Rs.20,00,000 Rs.8,00,000

Less Costs:

Material, Labor and overhead 400,000 750,000 350,000

incurred

Overhead allocated 40,000 750,000 35,000

Rent 50,000 50,000 50,000

Depreciation 300,000 300,000 300,000

Total Costs 790,000 1,175,000 735,000

Earning before taxes 210,000 825,000 65,000

Less taxes 84,000 330,000 26,000

Earning after taxes 126,000 495,000 35,000

If the company sets a required rate of return of 20% after taxes, should this project be accepted?

Assignment 3
Q.1 Firm purchased plant Rs. 150,000; additional cost will be added in plant cost Rs.70,000. Project is
forecast for five years, details are as follows:

 Sales 15000 units for first year [growth of sales expected to be 12% per year for the entire life of
project].
 Working capital required at the start of project 10,000.
 Sales price Rs. 37 per unit
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 Variable cost of sales Rs. 15 per unit

 It is assumed that inflation will be 5% in coming years which will impact on selling price of
product and variable cost.
 Fixed expenses Rs. 15,000(excluding depreciation)

Firm uses diminishing Balance Method [rate20%] and tax rate 35%. Assume that plant sold at the end of
the project at Rs. 50,000. Working capital will be recovered only 85% of invested amount. Cost of capital
will be calculated with the support of below mentioned data

Risk free rate 9.5%

Beta 1.25

Risk Premium 7%

Cost of debt 9%

Debt to equity ratio (D/E) 0.65x

Calculate

NPV and IRR