Project selection

A. Problems on net present value and profitability index

a. Net present value

• Cash inflows = PAT + Depreciation

b. Profitability index (PI)

• Profitability index = present value of cash inflows

present value of cash outflows

problems will be of three types

A. Only cash flows are given

B. PBDT/PBT is given

C. PAT is given

A. Only cash flows are given

1. Vindyachal Industries Ltd is desiring to buy a new

machine. The cash flows expected are as under

a. Initial cash outflows Rs 4,20,000/-.

b. Cash inflows

Year Rupees

1 1.60,000
2 1,50,000
3 1,40,000
4 1,55,000
5 2,00,000
The cost of capital is 10%. Present value at 10% for
years 1 to 5 is 0.91, 0.83, 0.75, 0.68, 0.62

Advise the management whether the new machine

should be bought or not using NPV method

Problem No 2

A company has an option to choose between to

machines P and Q.

Details of both the machines are as under

Particulars Machine P Machine Q

Capital investment 20,00,000 10,00,000

Inflows for years

1 6,00,000 5,00,000
2 4,00,000 4,50,000
3 4,00,000 3,00,000
4 3,50,000 3,00,000
5 4,00,000 2,00,000

PV factor at 14% for five years – 0.88, 0.77, 0.68,

0.59, 0.52

Using NPV and PI method,

advise the management as to which of the two
machines are to be considered.
3. Sugandhi Agarbatties ltd is considering two mutually
exclusive projects. Bothe the project have an useful
life of 5 years and the cost of capital is 10%. The
initial outlay is Rs 2,00,000/-

The future cash inflows of project I and project II are as

follows

Year Project I Project II

1 35,000 1,18,000
2 80,000 60,000
3 90,000 40,000
4 75,000 14,000
5 20,000 13,000

The present value factors for years 1 to 5 are 0.909,

0.826, 0.751, 0.673 and 0.621

You are required to evaluate the projects based on

NPV

4. Hathras Silks Ltd has an option to choose between to

machines X and Y.

Details of both the machines are as under

Particulars Machine X Machine Y

Capital investment 22,00,000 12,00,000

Inflows for years

1 6,10,000 4,80,000
2 4,00,000 4,50,000
3 4,00,000 3,10,000
4 5,50,000 4,40,000
 5 4,00,000 2,05,000

PV factor at 14% for five years – 0.88, 0.77, 0.68, 0.59,

0.52

Using NPV and PI method,

advise the management as to which of the two
machines are to be considered.

B. PBDT/PBT is given

1. S Ltd is considering purchase of one of the two similar

machines.

The initial cost of machine A is Rs 1,50,000/- and that

of machine B is Rs 1,25,000/-. Life is 5 years for both
the machines with no scrap at the end of their useful
life. Depreciation 20% SLM and tax rate is 30%.

Expected PBDT and pv factor for the next 5 years at

10% discount rate is as under

Year P.V. Factor Machine A Machine B

s

1 0.909 80,000 70,000

2 0.826 90,000 84,000
3 0.751 1,04,000 1,00,000
4 0.683 1,10,000 1,08,000
5 0.621 1,20,000 1,24,000

You are required to calculate the net present value of

each of the two machines at 10% discount factor and
give your comments on which machine is to be
purchased.

2. M/s Bell Ltd is considering purchasing a machine. Two

machines A and B under under consideration.
 From the following details as under give your opinion
on the choice of the two machines as per NPV and PI
method

Particulars Machine A Machine B

Capital investment 2,00,000 3,00,000

Life in years 5 years 5 years

PBT
1 89,000 1,25,000
2 94,000 1,31,000
3 1,04,000 1,43,000
4 1,23,000 1,59,000
5 1,55,000 1,93,000
6 2,36,000 2,27,000

Cost of capital is 10% and p/v factors are 0.909,

0.826, 0.751, 0.683, 0.621 and 0.564

C. PAT is given

1. The cost of a machine is Rs 5 lakhs and its salvage

value at the end of useful life of 5 years is Rs
50,000/-. The tax rate is 50%.

The company follows straight line method of

providing depreciation. Use 10% present value factor.

Year PAT

1 1,20,000
2 2,00,000
3 2,10,000
4 2,90,000
5 1,80,000
2. M/s OCM Ltd is considering purchasing a machine.
Two machines A and B under under consideration.

From the following details as under give your opinion

on the choice of the two machines as per NPV and PI
method

Particulars Machine A Machine B

Capital 4,00,000 5,50,000

investment

Life in years 5 years 5 years

PAT
1 14,000 15,000
2 14,000 30,000
3 40,000 40,000
4 20,000 40,000
5 15,000 20,000

Cost of capital is 10% and p/v factors are 0.909,

0.826, 0.751, 0.683, 0.621 and 0.564

B. Problems on payback period and discounted payback

period method

1. A Ltd is considering to buy a new machine. The new

machine will have a life of 5 years.

The expected cash outflows and inflows are as under

Year Cash flows

0 (-ve means cash (20,000)

outflows)
 1 8,000
2 6,000
3 5,800
4 3,000
5 3,000

Calculate

1. Payback period
2. Discounted payback period assuming discount
factor of 10%. Pv factors being 0.91, 0.83, 0.75,
0.68 and 0.62

Problem no 2

Compute the discounted payback period from the

following data

1. Initial cash flows Rs 1,00,000/-

2. Estimated life is 5 years. Depreciation on SLM at 20%.

3. PV factors at 15% discount factor for years 1 to 5 is

0.87, 0.76, 0.66, 0.57 and 0.50

4. PBDT for years 1 to 5 are Rs 20,000, 30,000, 40,000,

50,000 and 60,000/-. Tax rate is 20%.

Problem no 3

P Ltd is considering one of the two machines which are

currently available in the market.

The cost of capital is 10% and the corporate tax rate is

40%

The following are the details for both the machines.

 Particulars Machine X Machine Y

Cost of the 20,00,000 30,00,000

machine

Life 5 years 6 years

PBDT 6,00,000 9,00,000

Depreciation is to be calculated on SLM.

Which of the two machines is to be selected as per

discounted payback period method.

Accounting rate of return method (ARR)

Formula

1. Based on original investment

• Average net profit after tax + depreciation

original investment

• Original investment = cash outflows

• Average net profit after tax = total net

profits/no of years

2. Based on Average investment

• Average net profit after tax + depreciation

average investment

• Average investment
= (cash outflows – scrap) + additional wkg capital +
scrap
2

• Average net profit after tax = total net

profits/no of years

Note

1.Cash inflows = PAT + depreciation

2.If PAT figure and information of depreciation is

given then work out the cash flows by adding
PAT + depreciation.

3.If only PAT figure is given and no information is

given about depreciation, then consider PAT =
cash outflows.

Problems on ARR method

1. Calculate ARR from the following data

Particulars Amount

Cost 5,20,000

PAT

1 30,000

2 60,000

3 70,000

4 90,000
 5 1,10,000

Estimated life is 5 years

Estimated scrap value = Rs 20,000

2. Calculate ARR from the following data

Particulars Amount

Cost 1,20,000

PAT

1 10,000

2 30,000

3 40,000

4 60,000

5 40,000

Calculate the accounting rate of return and average

rate of return. (average rate of return = return on
average investment). Estimated scrap Rs 10,000/-

3. A Ltd is planning to choose between two equipments,

the details of which are as under. The PAT is as under

Year High speed Low speed

1 25,000 10,000

2 15,000 12,000
 3 10,000 18,000

4 12,000 25,000

5 6,000 12,000
Both the machines will have a cash outflow of Rs
50,000/-. Calculate the ARR of both these machines.
Problems on ARR method

4. D Ltd is planning to choose between two projects, the

details of which are as under. The PAT are as under

Year Project A Project B

1 25,000 22,000

2 20,000 22,000

3 30,000 38,000

4 42,000 45,000

5 16,000 10,000

Both the machines will have a cash outflow of Rs

1,20,000/-. Calculate the ARR of both these machines.
Depreciation is to be provided on SLM Method. Scrap at
the end of the useful life is Rs 10,000/- for both the
machines.

Internal rate of return method

1. M/s ABC Ltd has decided to invest in a machine whose

cost is Rs 2,00,000/-.
 The net yearly cash flows and the pv factors are as
under

Present value factors

Year Cash inflows 10% 15%

1 35,000 0.909 0.870

2 35,000 0.826 0.756
3 35,000 0.751 0.658
4 35,000 0.683 0.572
5 35,000 0.621 0.497
6 40,000 0.564 0.432
7 50,000 0.513 0.376
8 75,000 0.467 0.327
9 40,000 0.424 0.284
10 16,000 0.386 0.247

Calculate the IRR with the help of 10% and 15%

discounting tables

2. M/s Sunshine Limited has an investment opportunity

to invest Rs 40,000/- with the following net cash
flows. Calculate the IRR

Year Cash pv factors

inflows
@10% @15
%
1 7,000 0.909 0.870
2 7,000 0.826 0.756
3 7,000 0.751 0.868
4 7,000 0.683 0.572
5 7,000 0.621 0.497
6 8,000. 0.564 0.432
7 10,000 0.513 0.376
8 15,000 0.467 0.327
 9 10,000 0.424 0.284
10 4,000 0.386 0.247

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3. Calculate IRR from the following data

The Details of PBT, pv factors @ 12% and 14% of a project

are as under

p/v factors

Year PBT 12% 14%

1 10,00,000 0.893 0.877

2 30,00,000 0.797 0.769
3 30,00,000 0.712 0.675
4 20,00,000 0.636 0.592
5 10,00,000 0.567 0.519

The cost of the project is Rs 2,00,00,000 and the salvage

value will be Rs Nil. Tax rate is 55%.

Work out the IRR by taking help of 12% and 14% p/v
factors table.
Combined sums

Problem No. 1

The cost of a machine is Rs 5 lakhs and its salvage value

at the end of useful life of 5 years is Rs 50,000/-. The tax
rate is 50%.

The company follows straight line method of providing

depreciation. Use 10% present value factor.

Year PBT

1 1,20,000
2 2,00,000
3 2,10,000
4 2,90,000
5 1,80,000

Calculate

1. Net present value

2. Profitability index

3. Discounted payback period