Advanced Capital Budgeting

Question 1.
Skylark Airways is planning to acquire a light commercial aircraft for flying class clients at an
investment of ₹ 50,00,000. The expected cash flow after tax for the next three years is as follows: (₹)
Year 1 Year 2 Year 3
CFAT Probability CFAT Probability CFAT Probability
14,00,000 0.1 15,00,000 0.1 18,00,000 0.2
18,00,000 0.2 20,00,000 0.3 25,00,000 0.5
25,00,000 0.4 32,00,000 0.4 35,00,000 0.2
40,00,000 0.3 45,00,000 0.2 48,00,000 0.1
The Company wishes to take into consideration all possible risk factors relating to airline operations.
The company wants to know:
1. The expected NPV of this venture assumes independent probability distribution with 6 per cent
risk free rate of interest.
2. The possible deviation in the expected value.
3. How would standard deviation of the present value distribution help in Capital Budgeting
decisions?

Question 2.
Cyber Company is considering two mutually exclusive projects. Investment outlay of both the projects
is ₹ 5,00,000 and each is expected to have a life of 5 years. Under three possible situations their
annual cash flows and probabilities are as under:
Cash Flow (₹)
Situation Probabilities Project A ProjectB
Good 0.3 6,00,000 5,00,000
Normal 0.4 4,00,000 4,00,000
Worse 0.3 2,00,000 3,00,000
The cost of capital is 7 per cent, which project should be accepted? Explain with workings.

Question 3.
A company is considering Projects X and Y with following information:
Project Expected NPV (₹) Standard deviation
X 1,22,000 90,000
Y 2,25,000 1,20,000
(i) Which project will you recommend based on the above data?
(ii) Explain whether your opinion will change, if you use coefficient of variation as a measure of risk.
(iii) Which measure is more appropriate in this situation and why?

Question 4.
KLM Ltd., is considering taking up one of the two projects-Project-K and Project-So Both the
projects having same life require equal investment of ₹ 80 lakhs each. Both are estimated to have
almost the same yield. As the company is new to this type of business, the cash flow arising from
the projects cannot be estimated with certainty. An attempt was therefore made to use probability
to analyse the pattern of cash flow from other projects during the first year of operations. This
pattern is likely to continue during the life of these projects. The results of the analysis are as
follows:
Project K Project S
Cash Flow (in ₹) Probability Cash Flow (in ₹) Probability
11 0.10 09 0.10
13 0.20 13 0.25
15 0.40 17 0.30
17 0.20 21 0.25
19 0.10 25 0.10
Required:
(i) Calculate variance, standard deviation and co-efficient of variance for both the projects.
(ii) Which of the two projects is riskier?

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Question 5.
Project X and Project Y are under the evaluation of XY Co. The estimated cash flows and their
probabilities are as below:
Project X : Investment (year 0) ₹ 70 lakhs
Probability weights 0.30 0.40 0.30
Years ₹ lakhs ₹ lakhs ₹ lakhs
1 30 50 65
2 30 40 55
3 30 40 45

Project Y: Investment (year 0) ₹ 80 lakhs.

Probability weighted Annual cash flows through life
₹ lakhs
0.20 40
0.50 45
0.30 50
1. Which project is better based on NPV, criterion with a discount rate of 10%?
2. Compute the standard deviation of the present value distribution and analyse the inherent
risk of the projects.

Question 6.
Shivam Ltd. is considering two mutually exclusive projects A and B. Project A costs ₹ 36,000 and
project B ₹ 30,000. You have been given below the net present value probability distribution for
each project.
Project A Project B
NPV estimates (₹) Probability NPV estimates (₹) Probability
15,000 0.2 15,000 0.1
12,000 0.3 12,000 0.4
6,000 0.3 6,000 0.4
3,000 0.2 3,000 0.1
(i) Compute the expected net present values of projects A and B.
(ii) Compute the risk attached to each project i.e. standard deviation of each probability distribution.
(iii) Compute the profitability index of each project. Profitability Index = pvci/pvco
(iv) Which project do you recommend? State with reasons.

Question 7.
Following are the estimates of the net cash flows and probability of a new project of M/s X Ltd.:
Year P = 0.3 P = 0.5 P = 0.2
Initial investment 0 4,00,000 4,00,000 4,00,000
Estimated net after tax cash inflows per year 1 to 5 1,00,000 1,10,000 1,20,000 These are
Estimated salvage value (after tax) 5 20,000 50,000 60,000 the actual
Required rate of return from the project is 10%. Find: shall not be
(i) The expected NPV of the project. multiplied
(ii) The best case and the worst case NPVs. Determine on the basis of NPV. with
probability.
(iii) The probability of occurrence of the worst case if the cash flows are perfectly dependent on
overtime and independent overtime.
(iv) Standard deviation and coefficient of variation assuming that there are only three streams of cash
flow, which are represented by each column of the table with the given probabilities.
(v) Coefficient of variation of X Ltd. on its average project which is in the range of 0.95 to 1.0. If the
coefficient of variation of the project is found to be less risky than average, 100 basis points are
deducted from the Company’s cost of Capital Should the project be accepted by X Ltd?

Question 8.
XY Ltd. has under its consideration a project with an initial investment of ₹ 1,00,000. Three probable
cash inflow scenarios with their probabilities of occurrence have been estimated as below:
Annual cash inflow (₹) 20,000 30,000 40,000

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Probability 0.1 0.7 0.2

The project life is 5 years and the desired rate of return is 20%. The estimated terminal values for the
project assets under the three probability alternatives, respectively, are ₹ 0, 20,000 and 30,000.
You are required to:
(i) Find the probable NPV;
(ii) Find the worst-case NPV and the best-case NPV; and
(iii) State the probability occurrence of the worst case, if the cash flows are perfectly positively
correlated over time.

Question 9.
XYZ Ltd. is considering a project for which the following estimates are available:
₹
Initial Cost of the project 10,00,000
Sales price/unit 60
Cost/unit 40
Sales volumes
Year 1 20000 units
Year 2 30000 units
Year 3 30000 units
Discount rate is 10% p.a.
You are required to measure the sensitivity of the project in relation to each of the following
parameters:
1. Sales Price/unit
2. Unit cost
3. Sales volume
4. Initial outlay and
5. Project lifetime Taxation may be ignored.

Question 10.
From the following details relating to a project, analyse the sensitivity of the project to changes in initial
project cost, annual cash inflow and cost of capital:
Initial Project Cost (₹) 1,20,000
Annual Cash Inflow (₹) 45,000
Project Life (Years) 4
Cost of Capital 10%
To which of the three factors, the project is most sensitive? (Use annuity factors: for 10% 3.169 and
11% 3.103).

Question 11.
Red Ltd. is considering a project with the following Cash flows:
Years Cost of Plant Recurring Cost Savings Do not net off the cost
and saving because we
0 10,000
have to cheque their
1 4,000 12,000 effect individually as
2 5,000 14,000 well.
The cost of capital is 9%. Measure the sensitivity of the project to changes in the levels of plant
value, running cost and savings (considering each factor at a time) such that the NPV becomes
zero. The P.V. factor at 9% are as under:
Year Factor
0 1
1 0.917
2 0.842
Which factor is the most sensitive to affect the acceptability of the project?

Question 12.
The Easygoing Company Limited is considering a new project with initial investment, for a product
“Survival”. It is estimated that the IRR of the project is 16% having an estimated life of 5 years.

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The Financial Manager has studied that project with sensitivity analysis and informed us that annual
fixed cost sensitivity is 7.8416%, whereas cost of capital (discount rate) sensitivity is 60%.
Other information available are:
Profit Volume Ratio (P/V) is 70%, Variable cost ₹ 60/- per unit Annual Cash Flow ₹ 57,500/-
Ignore Depreciation on initial investment and impact of taxation.
Calculate
(i) Initial Investment of the Project
(ii) Net Present Value of the Project
(iii) Annual Fixed Cost
(iv) Estimated annual unit of sales
(v) Break Even Units
Cumulative Discounting Factor for 5 years
8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18%
3.993 3.890 3.791 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127

Question 13.
Unnat Ltd. is considering investing ₹ 50,00,000 in a new machine. The expected life of the machine is
five years and has no scrap value. It is expected that 2,00,000 units will be produced and sold each
year at a selling price of ₹ 30.00 per unit. It is expected that the variable costs to be ₹ 16.50 per unit
and fixed costs to be ₹ 10,00,000 per year. The cost of capital of Unnat Ltd. is 12% and acceptable
level of risk is 20%.
You are required to measure the sensitivity of the project’s net present value to a change in the
following project variables:
1. sale price;
2. sales volume;
3. variable cost;
On further investigation it is found that there is a significant chance that the expected sales volume
of 2,00,000 units per year will not be achieved. The sales manager of Unnat Ltd. suggests that sales
volumes could depend on expected economic states which could be assigned the following
probabilities:
State of Economy Annual Sales (in Units) Prob.
Poor 1,75000 0·30
Normal 2,00,000 0·60
Good 2,25,000 0·10
Calculate expected net present value of the project and give your decision whether the company
should accept the project or not.

Question 14.
The Textile Manufacturing Company Ltd., is considering one of two mutually exclusive proposals,
Projects M and N, which require cash outlays of ₹ 8,50,000 and ₹ 8,25,000 respectively. The
certainty-equivalent (C.E) approach is used in incorporating risk in capital budgeting decisions. The
current yield on government bonds is 6% and this is used as the risk free rate. The expected net cash
flows and their certainty equivalents are as follows:
Project M Project N
Year-end Cash Flow ₹ C.E. Cash Flow ₹ C.E.
1 4,50,000 0.8 4,50,000 0.9
2 5,00,000 0.7 4,50,000 0.8
3 5,00,000 0.5 5,00,000 0.7
Present value factors of ₹ 1 discounted at 6% at the end of year 1, 2 and 3 are 0.943, 0.890 and 0.840
respectively. Required:
(i) Which project should be accepted?
(ii) If risk adjusted discount rate method is used, which project would be appraised with a higher rate
and why?

Question 15.
Determine the risk adjusted net present value of the following projects:
X Y Z

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Net cash outlays (₹) 2,10,000 1,20,000 1,00,000

Project life 5 years 5 years 5 years
Annual Cash inflow (₹) 70,000 42,000 30,000
Coefficient of variation 1.2 0.8 0.4
The Company selects the risk-adjusted rate of discount on the basis of the coefficient of variation:
Coefficient of Variation Risk-Adjusted Rate of P.V. Factor 1 to 5 years At risk
Return adjusted rate of discount
0.0 10% 3.791
0.4 12% 3.605
0.8 14% 3.433
1.2 16% 3.274
1.6 18% 3.127
2.0 22% 2.864
More than 2.0 25% 2.689

Question 16.
New Projects Ltd. is evaluating 3 projects, P-I, P-II, P-III. Following information is available in respect
of these projects:
P-I P-II P-III
Cost ₹ 15,00,000 ₹ 11,00,000 ₹ 19,00,000
Inflows-Year 1 6,00,000 6,00,000 4,00,000
Year 2 6,00,000 4,00,000 6,00,000
Year 3 6,00,000 5,00,000 8,00,000
Year 4 6,00,000 2,00,000 12,00,000
Risk Index 1.80 1.00 0.60
Minimum required rate of return of the firm is 15% and applicable tax rate is 40%. The risk free interest
rate is 10%.
Required:
(i) Find out the risk-adjusted discount rate (RADR) for these projects.
(ii) Which project is the best?

Question 17.
A firm has projected the following cash flows from a project under evaluation:
Year ₹ lakhs
(1+RR) (1+IR) = (1+NR)
0 (70)
1 30
2 40
3 30
The above cash flows have been made at expected prices after recognizing inflation. The firm’s cost
of capital is 10%. The expected annual rate of inflation is 5%.
Show how the viability of the project is to be evaluated.

Question 18.
Shashi Co. Ltd has projected the following cash flows from a project under evaluation:
Year 0 1 2 3
₹ (in lakhs) (72) 30 40 30
The above cash flows have been made at expected prices after recognizing inflation. The firm’s
cost of capital is 10%. The expected annual rate of inflation is 5%. Show how the viability of the
project is to be evaluated. PVF at 10% for 1-3 years are 0.909, 0.826 and 0.751.

Question 19.
KLM Ltd. requires ₹ 15,00,000 for a new project. Useful life of project is 3 years.
Salvage value - NIL.
Depreciation is ₹ 5,00,000 p.a.
Given below are projected revenues and costs (excluding depreciation) ignoring inflation:
Year → 1 2 3
Revenues in ₹ 10,00,000 13,00,000 14,00,000

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Costs in ₹ 5,00,000 6,00,000 6,50,000

Applicable tax rate is 35%. Assume cost of capital to be 14% (after tax). The inflation rates for revenues
and costs are as under:
Year Revenues % Costs %
1 9 10 apply inflation rate individually on revenue
and on cost Then calculate NPV.
2 8 9
3 6 7
PVF at 14%, for 3 years =0.877, 0.769 and 0.675 Show amount to the nearest rupee in calculations.
You are required to calculate the net present value of the project.

Question 20.
A firm has an investment proposal, requiring an outlay of ₹ 80,000. The investment proposal is
expected to have two years economic life with no salvage value. In year 1, there is a 0.4 probability
that cash inflow after tax will be ₹ 50,000 and 0.6 probability that cash inflow after tax will be ₹
60,000. The probability assigned to cash inflow after tax for the year 2 is as follows:
The cash inflow year 1 ₹ 50,000 ₹ 60,000
The cash inflow year 2 Probability Probability
With the NPV of 1 year ₹ 24,000 0.2 ₹ 40,000 0.4 if the npv of
₹ 32,000 0.3 ₹ 50,000 0.5 year 2 is
₹ 44,000 0.5 ₹ 60,000 0.1 60000
The firm uses a 10% discount rate for this type of investment. Required:
(i) Construct a decision tree for the proposed investment project and calculate the expected net present value
(NPV).
(ii) What net present value will the project yield, if the worst outcome is realized? What is the probability of
occurrence of this NPV?
(iii) What will be the best outcome and the probability of that occurrence?
(iv) Will the project be accepted?
(Note: 10% discount factor 1 year 0.909; 2 year 0.826)

Question 21.
Jumble Consultancy Group has determined relative utilities of cash flows of two forthcoming
projects of its client company as follows:
Cash Flow in ₹ -15000 -10000 -4000 0 15000 10000 5000 1000
Utilities -100 -60 -3 0 40 30 20 10
The distribution of cash flows of project A and Project B are as follows:
Project A
Cash Flow (₹) -15000 - 10000 15000 10000 5000
Probability 0.10 0.20 0.40 0.20 0.10
Project B
Cash Flow (₹) - 10000 -4000 15000 5000 10000
Probability 0.10 0.15 0.40 0.25 0.10
Which project should be selected and why ?

Question 22.
A & Co. is contemplating whether to replace an existing machine or to spend money on overhauling
it. A & Co. currently pays no taxes. The replacement machine costs ₹ 90,000 now and requires
maintenance of ₹ 10,000 at the end of every year for eight years. At the end of eight years it would
have a salvage value of ₹ 20,000 and would be sold. The existing machine requires increasing
amounts of maintenance each year and its salvage value falls each year as follows:
Year Maintenance (₹) Salvage (₹)
Present 0 40,000
1 10,000 25,000
2 20,000 15,000
3 30,000 10,000
4 40,000 0
The opportunity cost of capital for A & Co. is 15%. Required:

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When should the company replace the machine?

(Notes: Present value of an annuity of Re. 1 per period for 8 years at interest rate of 15% : 4.4873;
present value of Re. 1 to be received after 8 years at interest rate of 15% : 0.3269).

Question 23.
A company has an old machine having book value zero – which can be sold for ₹ 50,000. The
company is thinking to choose one from following two alternatives:
(i) To incur additional cost of ₹ 10,00,000 to upgrade the old existing machine.
(ii) To replace old machine with a new machine costing ₹ 20,00,000 plus installation cost ₹ 50,000.
Both above proposals envisage useful life to be five years with salvage value to be nil. The expected
after tax profits for the above three alternatives are as under :
Year Old existing Machine (₹) Upgraded Machine (₹) New Machine (₹)
1 5,00,000 5,50,000 6,00,000
2 5,40,000 5,90,000 6,40,000
3 5,80,000 6,10,000 6,90,000
4 6,20,000 6,50,000 7,40,000
5 6,60,000 7,00,000 8,00,000
The tax rate is 40 percent.
The company follows a straight line method of depreciation. Assume cost of capital to be 15 per
cent.
P.V.F. of 15%, 5 = 0.870, 0.756, 0.658, 0.572 and 0.497. You are required to advise the company as to
which alternative is to be adopted. Depreciation shall be added to cfat and it will be solved as per incremental for the new two
option as compare to old option.

Question 24.
Company X is forced to choose between two machines A and B. The two machines are designed
differently but have identical capacity and do exactly the same job. Machine A costs ₹ 1,50,000 and
will last for 3 years. It costs ₹ 40,000 per year to run. Machine B is an ‘economy’ model costing only ₹
1,00,000, but will last only for 2 years, and costs ₹ 60,000 per year to run. These are real cash flows.
The costs are forecasted in rupees of constant purchasing power. Ignore tax. Opportunity cost of
capital is 10 percent. Which machine company X should buy?

Question 25.
Company Y is operating an elderly machine that is expected to produce a net cash inflow of ₹ 40,000
in the coming year and ₹ 40,000 next year. Current salvage value is ₹ 80,000 and next year’s value is ₹
70,000. The machine can be replaced now with a new machine, which costs ₹ 1,50,000, but is much
more efficient and will provide a cash inflow of ₹ 80,000 a year for 3 years. Company Y wants to
know whether it should replace the equipment now or wait a year with the clear understanding that
the new machine is the best of the available alternatives and that it in turn be replaced at the optimal
point. Ignore tax. Take opportunity cost of capital as 10 per cent. Advise with reasons.

Question 26.
A machine used on a production line must be replaced at least every four years. Costs incurred to run
the machine according to its age are:

Age of the Machine (years)

0 1 2 3 4
Purchase price (in ₹) 60,000
Maintenance (in ₹) 16,000 18,000 20,000 20,000
Repair (in ₹) 0 4,000 8,000 16,000
Scrap Value (in ₹) 32,000 24,000 16,000 8,000
Future replacement will be with identical machines with the same cost. Revenue is unaffected by the
age of the machine. Ignoring inflation and tax, determine the optimum replacement cycle. PV factors
of the cost of capital of 15% for the respective four years are 0.8696, 0.7561, 0.6575 and 0.5718.

Question 27.
Trouble Free Solutions (TFS) is an authorized service center of a reputed domestic air conditioner
manufacturing company. All complaints/service related matters of Air conditioner are attended by

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this service center. The service center employs a large number of mechanics, each of whom is
provided with a motor bike to attend the complaints. Each mechanic travels approximately 40000
kms per annum. TFS decides to continue its present policy of always buying a new bike for its
mechanics but wonders whether the present policy of replacing the bike every three years is optimal
or not. It is of belief that as new models are entering into the market on a yearly basis, it wishes to
consider whether a replacement of either one year or two years would be a better option than the
present three year period. The fleet of bikes is due for replacement shortly in the near future.
The purchase price of the latest model bike is ₹ 55,000. Resale value of used bike at current prices in
market is as follows:
Period ₹
1 Year old 35,000
2 Year old 21,000
3 Year old 9,000
Running and Maintenance expenses (excluding depreciation) are as follows:
Year Road Taxes Insurance etc. (₹) Petrol Repair Maintenance etc. (₹)
1 3,000 30,000
2 3,000 35,000
3 3,000 43,000
Using the opportunity cost of capital as 10% you are required to determine the optimal replacement
period of the bike.

Question 28 -
Determine NPV of the project with the following information:
Initial Outlay of project ₹ 40,000
Annual revenues (Without inflation) ₹ 30,000
Annual costs excluding depreciation (Without inflation) ₹ 10,000
Useful life 4 years
Salvage value Nil
Tax Rate 50%

Cost of Capital (Including inflation premium of 10%) 12%

Question 29 -
XYZ Ltd. requires ₹ 8,00,000 for a unit. Useful life of project - 4 years. Salvage value - Nil. Depreciation Charge ₹
2,00,000 p.a. Expected revenues & costs (excluding depreciation) ignoring inflation.
Year 1 2 3 4
Revenues ₹ 6,00,000 ₹ 7,00,000 ₹ 8,00,000 ₹ 8,00,000
Costs ₹ 3,00,000 ₹ 4,00,000 ₹ 4,00,000 ₹ 4,00,000

Tax Rate 60% cost of capital 10% (including inflation premium).

Calculate NPV of the project if inflation rates for revenues & costs are as follows:
Year Revenues Costs
1 10% 12%
2 9% 10%
3 8% 9%
4 7% 8%

Question 30 -
Possible net cash flows of Projects A and B at the end of first year and their probabilities are given
below. Discount rate is 10 percent. For both the projects, initial investment is ₹ 10,000. Calculate the
expected net present value for each project. State which project is preferable?
Possible Event Project A Project B
Cash Flow (₹) Probability Cash Flow (₹) Probability
A 8,000 0.10 24,000 0.10
B 10,000 0.20 20,000 0.15
C 12,000 0.40 16,000 0.50
D 14,000 0.20 12,000 0.15

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E 16,000 0.10 8 ,000 0.10

Question 31 -
Probabilities for net cash flows for 3 years of a project are as follows:
Year 1 Year 2 Year 3
Cash Flow (₹) Probability Cash Flow (₹) Probability Cash Flow (₹) Probability
2,000 0.1 2,000 0.2 2,000 0.3
4,000 0.2 4,000 0.3 4,000 0.4
6,000 0.3 6,000 0.4 6,000 0.2
8,000 0.4 8,000 0.1 8,000 0.1
Calculate the expected net present value of the project using a 10 percent discount rate if the Initial
investment of the project is ₹ 10,000.

Question 32 -
Calculate Variance and Standard Deviation of Project A and Project B on the basis of following information:
Possible Event Project A Project B
Cash Flow (₹) Probability Cash Flow (₹) Probability
A 8,000 0.10 24,000 0.10
B 10,000 0.20 20,000 0.15
C 12,000 0.40 16,000 0.50
D 14,000 0.20 12,000 0.15
E 16,000 0.10 8,000 0.10

Question 33 -
Calculate Coefficient of Variation of Project A and Project B based on the following information:
Possible Event Project A Project B
Cash Flow (₹) Probability Cash Flow (₹) Probability
A 10000 0.10 26,000 0.10
B 12,000 0.20 22,000 0.15
C 14,000 0.40 18,000 0.50
D 16,000 0.20 14,000 0.15
E 18,000 0.10 10,000 0.10

Question 34 -
An enterprise is investing ₹ 100 lakhs in a project. The risk-free rate of return is 7%. Risk premium
expected by the Management is 7%. The life of the project is 5 years. Following are the cash flows
that are estimated over the life of the project:
Year Cash flows (₹ in lakhs)
1 25
2 60
3 75
4 80
5 65
Calculate Net Present Value of the project based on Risk free rate and also on the basis of Risks
adjusted discount rate.

Question 35 -
If Investment proposal costs ₹ 45,00,000 and the risk free rate is 5%, calculate net present value
under certainty equivalent technique.
Year Expected cash flow (₹) Certainty Equivalent coefficient
1 10,00,000 0.90
2 15,00,000 0.85
3 20,00,000 0.82
4 25,00,000 0.78

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Question 36 -
X Ltd. is considering its new project with the following details:
Sr. No. Particulars Figures
1 Initial capital cost ₹ 400 Cr.
2 Annual unit sales 5 Cr.
3 Selling price per unit ₹ 100
4 Variable cost per unit ₹ 50
5 Fixed costs per year ₹ 50 Cr.
6 Discount Rate 6%
Required:
1. Calculate the NPV of the project.
2. Compute the impact on the project’s NPV considering a 2.5 per cent adverse variance in each variable.
Which variable is having maximum effect?
Consider Life of the project as 3 years.

Question 37 -
XYZ Ltd. is considering a project “A” with an initial outlay of ₹ 14,00,000 and the possible three cash inflow
attached with the project as follows:
Particulars Year 1 Year 2 Year 3
Worst case 450 400 700
Most likely 550 450 800
Best case 650 500 900
Assuming the cost of capital as 9%, determine NPV in each scenario. If XYZ Ltd is certain about the
most likely result in the first two years but uncertain about the third year’s cash flow, analyze what
will be the NPV expecting the worst scenario in the third year.

Question 38 -
L & R Limited wishes to develop new virus-cleaner software. The cost of the pilot project would be ₹
2,40,000. Presently, the chances of the product being successfully launched on a commercial scale
are rated at 50%. In case it does succeed. L&R can invest a sum of ₹ 20 lacs to market the product.
Such an effort can generate perpetually, an annual net after tax cash income of ₹ 4 lacs. Even if the
commercial launch fails, they can make an investment of a smaller amount of ₹ 12 lacs with the
hope of gaining perpetually a sum of ₹ 1 lac. Evaluate the proposal, adopting a decision tree
approach. The discount rate is 10%.

Question 39 -
A Company named Roby’s cube decided to replace the existing Computer system of their
organisation. Original cost of the old system was ₹ 25,000 and it was installed 5 years ago. Current
market value of the old system is ₹ 5,000. Depreciation of the old system was charged with a life of
10 years with Estimated Salvage value as Nil. Depreciation of the new system will be charged with
life over 5 years. Present cost of the new system is ₹ 50,000. Estimated Salvage value of the new
system is ₹ 1,000. Estimated cost savings with the new system is ₹ 5,000 per year. Increase in sales
with the new system is assumed at 10% per year based on original total sales of ₹ 10,00,00.
Company follows a straight line method of depreciation. Cost of capital of the company is 10%
whereas the tax rate is 30%.

Question 40 -
X Ltd. is a taxi operator. Each taxi cost to company ₹ 4,00,000 and has a useful life of 3 years. The
taxi’s operating cost for each of 3 years and salvage value at the end of year is as follows:
Year 1 Year 2 Year 3
Operating Cost ₹ 1,80,000 ₹ 2,10,000 ₹ 2,38,000
Resale Value ₹ 2,80,000 ₹ 2,30,000 ₹ 1,68,000
You are required to determine the optimal replacement period of taxi if cost of capital of X Ltd. is 10%.

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