Problems on Capital Budgeting Techniques – TYBCOM

1. Broadcast Engineering consultant India is considering the purchase of a new machine which will replace
some operations. There are two alternative A and B. From the following information, prepare a
profitability statement and work out the payback period for each.
Model A Model B
Cost of the machine (`) 1,50,000 2,50,000
Estimated Life (years) 5 5
Additional Cost of Indirect Materials (`) 6,000 8,000
Estimated Savings in Scrap (`) 10,000 15,000
Additional Cost of Maintenance (`) 19,000 27,000
Estimated savings in direct wages:
Employees not required 15 20
Wages per employee p.a. (`) 6,000 6,000
Tax rate is 50%. Suggest which machine should be preferred.

2. HMT International Ltd. has an investment proposal of `40 lakhs. The expected cash inflow.
Year Profit (`) Year Profit (`)
1 7,00,000 6 9,00,000
2 7,00,000 7 10,00,000
3 8,00,000 8 10,00,000
4 8,00,000 9 8,00,000
5 9,00,000 10 6,00,000

The present value factor are:

Year @ 10% Year @ 10%
1 0.909 6 0.564
2 0.826 7 0.513
3 0.751 8 0.467
4 0.683 9 0.424
5 0.621 10 0.386
You are required to ascertain:
1. N.P.V.@ 10%
2. Profitability Index @ 10%
3. IRR

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3. The FCI Aravali Gypsum and Minerals (India) Ltd. has decided to increase its productive capacity to
meet an anticipated increase in demand for its products. The extent of this increase in capacity has still to
be determined and a management meeting has been called for to decide which of the following two
mutually exclusive Proposal I and II should be undertaken. On the basis of the information given below,
you are required to :
1. Evaluate the profitability (ignoring taxation and investment allowance of each of the proposals).
2. Advise management in deciding between Proposal I and Proposal II on the assumption of cost of capital
at 8%.
Proposal – I Proposal – II
` `
Building 50,000 1,00,000
Plant 2,00,000 3,00,000
Installation 10,000 15,000
Working Capital 50,000 65,000
Net Income
Annual Pre Depreciation Profits (Note i) 70,000 95,000
Other relevant Income Expenditure including sales promotion (Note ii) 15,000
Plant Scrap Value 10,000 15,000
Building Disposal Value (Note iii) 30,000 60,000
Note:
1. The investment life is 10 years.
2. An exceptional amount of expenditure on sales promotion of `15,000 will be spent in year 2 on Proposal
II. This has not been taken into account in calculating pre- depreciation profits.
3. It is not the intention to dispose of the building in ten years’ time. However, it is company policy to take
a notional figure into account for project evaluation purpose.
4. The present value of `1 at 8% discounting factor.

4. The directors of NHPC Ltd. Industries are contemplating the purchase of a new machine to replace a
machine which has been in operation in the factory for the last 5 years. Ignoring interest but considering
tax at 50% of net earnings, suggest which of the two alternatives should be preferred. The following are
the details.
Old Machine New Machine
Purchase Price `40,000 `60,000
Estimated Life of Machine 10 years 10 years
Machine running hrs per annum 2,000 2,000
Units per hour 24 36
Wages per hour `3 `5.25
Power per annum `2,000 `4,500
Consumable stores per annum `6,000 `7,500
All other charges per annum `8,000 `9,000
Material cost per unit `0.50 `0.50
Selling price per unit `1.25 `1.25
You may assume the above information regarding sales and cost of sales will hold goods throughout the
economic life of each of the machines. Depreciation has to be charged according to straight line method.

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5. Engineers India Limited (EIL) is considering the purchase of a machine. Two machines are available A
and B the cost of each machine is `2,00,000. Each has an expected life of 5 years.
The estimated profit before depreciation and tax of both the machines are as follows: (H.W)
Year Machine A (`) Machine B (`)
1 70,000 78,000
2 72,000 75,000
3 76,000 72,000
4 78,000 75,000
5 75,000 80,000
6 85,000 85,000
Bothe the machine has to be depreciated under the straight-line method and the average rate of income
tax may be taken at 50%. Ascertain which of the two machines will be profitable under:
i) Payback Period Method
ii) Average Rate of Return Method

6. A Company is considering the proposal of taking up a new project which requires an investment of
`.400 lakhs on machinery and other assets. The project is expected to yield the following earnings
(before depreciation and taxes) over the next five years:
Year 1 2 3 4 5
Earnings (` lakhs) 160 160 180 180 150
The cost of raising additional capital is 12% and assets have to be depreciated at 20% on written down
value basis. The scrap value at the end of the five years period may be taken as zero. Income tax
applicable to the company is 50%.
You are required to calculate the net present value of the project and advise the management to take
appropriate decision. Also calculate the Internal Rate of Return of the project.
Note: Present Value ` at different rates of interest are as follows:
Year 10% 12% 14% 16%
1 0.91 1.89 0.88 0.86
2 0.83 0.80 0.77 0.74
3 0.75 0.71 0.67 0.64
4 0.68 0.64 0.59 0.55
5 0.62 0.57 0.52 0.48

7. Container is producing articles mostly on hand labour and is considering replacing it by a new machine.
There are two alternatives models M and N of the new machine. Prepare a statement of profitability
showing the payback period from the following information. (H.W)
Old Machine New Machine
Estimated Life of Machine 4 years 5 years
Cost of Machine `9,000 `18,000
Estimated saving in scrap `500 `800
Estimated savings in direct wages `6,000 `8,000
Additional cost of maintenance `800 `1,000
Additional cost of Supervision `1,200 `1,800

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8. Management of Container Corporation of India is considering buying a machine for manufacturing
purpose. There are two machines available in the market which could serve the purpose. Details about
these two machines two machines are as below:
Machine X Machine Y

Estimated Life of Machine 5 years 5 years

Initial Investment `90,000 `90,000

Average income tax 50% 50%

Annual income estimated after depreciation but before tax:

`. `.
1st Year 33,000 40,200
2nd Year 48,000 43,200
3rd Year 50,400 51,000
4th Year 52,800 42,000
5th Year 54,000 52,800
Calculate:
a) Payback Period of both machines
b) Accounting rate of return of both machine

9. State Trading Corporation of India is considering the purchase of a machine. Two machines A and B are
available, the details of which are given below. You are requested to advise the company to which
machine is more profitable. (H.W)
i) Payback period method
ii) Average rate of return method
The income tax rate is 50%.
Particulars Machine A Machine B
Cost `2,50,000 `3,00,000
Life 6 Years 6 Years
Scrap Value `10,000 Nil
Profit (before depreciation and taxes) ` `

1st Year 1,00,000 80,000

nd
2 Year 1,20,000 1,40,000
rd
3 Year 1,40,000 1,60,000
4th Year 80,000 80,000
5th Year 1,00,000 80,000
6th Year 60,000 60,000

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10. 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 `1,00,000 each. The company pays tax 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 (`)
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 the help of above information you are required to calculate:

a) The Payback period of each project
b) The Average rate of return
c) The Net Present Value at 10%
d) Profitability Index at 10% discount rate

11. Water and Power Consultancy Service wants to install a new machine in place of existing old machine
which became obsolete. Two machines are considered for this purpose. The two models differ in cost,
output and cash flow. The estimated life of both the machine is 5 years.
(H.W)
Particulars Machine A Machine B
Cash outlay `2,50,000 `4,00,000
Anticipated after tax cash flows ` `

1st Year - 1,00,000

2nd Year 50,000 1,40,000
3rd Year 2,00,000 1,60,000
th
4 Year 1,40,000 1,70,000
th
5 Year 60,000 80,000
The company follows a straight line method of depreciation.
The company’s cost of capital is 16%.
You are required to make appraisal of the two offers and the advice the firm by using the following:
a) Payback period
b) Average rate of return
c) Profitability index
d) Net Present Value

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12. Bharat Electronics Ltd. (BEL) is considering the purchase of a new machine. Two alternative machines
A & B suggested each costing `4,00,000. Earning after taxation are expected to be as follows:
Particulars Machine A Machine B
1st Year 40,000 1,20,000
2nd Year 1,20,000 1,60,000
3rd Year 1,60,000 2,00,000
4th Year 2,40,000 1,20,000
5th Year 1,60,000 80,000
The Co’s target return on capital is 10%. You are required to compare the profitability of the machines and
state which alternative of the machines is financially preferable. Adopt NPV method and Profitability Index
Method.

13. Security Printing and Minting Corporation of India is considering of purchasing of new machine which
will carry out some operations performed by labour. X and Y are alternative models. From the following
information, you are required to prepare a profitable statement and give your recommendation under
payback period method and accounting rate of return.
(H.W)
Old Machine New Machine
Estimated Life of Machine 5 years 5 years
Cost of Machine `1,50,000 `2,50,000
Cost of Indirect Material `6,000 `8,000
Estimated saving in scrap `10,000 `15,000
Additional cost of maintenance `19,000 `27,000
Estimated savings in wages : employees not required `150 `200
Wages per employees `600 `600
Taxation rates to be regarded as 50% of profits

14. National Small Industries Corporation Limited Margao purchased a machine five years ago. A proposal
is under consideration to replace it by a new machine. The life of the machine is estimated to be 10
years. The existing machine can be sold at its written down value. As the cost accountant to the company
you are required to submit your recommendations based on the following information.
Old Machine New Machine
Initial Cost `25,000 `50,000
Machine hrs per annum 2,000 2,000
Wages per hour `1.20 `1.25
Power per hour `0.50 `2.00
Indirect materials per annum `3,000 `5,000
Other expenses per annum `12,000 `15,000
Cost of materials per unit `1 `1
Number of units produced per hour 12 18
Selling price per unit `2 `2
Interest to be paid at 10% on fresh capital invested.
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15. Rail Vikas Nigam Ltd. is planning to invest `10,00,000 in two projects X and Y which will require an
investment of `6,00,000 and `4,00,000 respectively. Profit before depreciation and tax is given below:
Year X (`) Y (`)
1 2,00,000 3,00,000
2 1,50,000 1,00,000
3 1,00,000 1,50,000
4 1,50,000 1,50,000
5 3,00,000 2,00,000
Compute:
a) NPV
b) PI

16. Northern Coalfields (NCL), considering investment in project for which the investment data are as
follows:
Capital outlays: `2,00,000 Depreciation: 20% p.a.
Forecasted annual income after charging depreciation and after all other charges:
Year (`)
1 1,40,000
2 1,40,000
3 1,20,000
4 1,20,000
5 80,000
Taxation may be assumed at 35% and cost of capital 9%.
Calculate:
a) Payback period
b) Rate of Return on Original Investment
c) Rate of Return on Average Investment
d) NPV
The present value of 1 at 9% discount factor is as follows:
Year
1 0.917
2 0.842
3 0.772
4 0.708
5 0.650