The document discusses capital budgeting and net present value (NPV) analysis. It provides an example calculation of NPV for an investment project with an initial cash outlay of $100,000, annual cash inflows of $200,000, annual cash outflows of $150,000 over 3 years, and a cost of capital of 10%. The NPV is calculated as $24,340, indicating the project should be accepted. It then analyzes the tolerate levels for changes in the cash outlay, project life, cash flows, and discount rate while still achieving a positive NPV.

1. Capital Budgeting
Decision
Presented BY
Dr Girish
Garg
Title

2. A capital budgeting decisions may be defined as the firm’s
decision to invest its current funds most efficiently in the long
term assets in anticipation of an expected flow of benefits over a
series of years.
Importance of investment decisions
1. They influence the firm’s growth in the long run.
2. They affect the risk of the firm.
3. They involve commitment of large amount of funds.
4. They are irreversible, or reversible at substantial loss.
5. They are among the most difficult decisions to make.
Introduction

3. Non-discounted cash
flow criteria
Payback period
Accounting rate
of return
Payback
Reciprocal
Payback
Profitability
Discounted cash flow
criteria
Net present
value
Internal rate of
return
Profitability
Index
Discounted
Payback
Period
Modified
Internal rate
of return
Modified Net
Present Value
Evaluation Criteria

4. It is a DCF technique that explicitly recognise the time value of money. It
correctly postulates that cash flows arising at different time period differ in
value and are comparable only when their equivalent present value are found
out.
Net present value (NPV) is the difference between the present value of cash inflows
and the present value of cash outflows over a period of time. NPV is used in capital
budgeting and investment planning to analyze the profitability of a projected
investment or project.
Net Present Value

5. Q1. A Company is considering an investment proposal, involving an initial
cash outlay Rs. 1,00,000. the proposal has an expected life of 3 years. The
proposal has annual expected cash outflow Rs. 1,50,000 and expected annual
cash inflow Rs. 2,00,000. The cost of capital is 10%. Calculate NPV and
evaluate the tolerate level of company if there is change in the value of
following.
1. Cash Outlay.
2. Expected life of project.
3. Net cash flow
4. Discount rate.
Numerical Question

6. NPV = PVCI –PVCO
PVCI = Expected Net Cash Flows * PVAF (10%,3)
PVAF (10%,3) =
1
(1+𝑖)1 +
1
(1+𝑖)2 +
1
(1+𝑖)3
PVAF (10%,3) =
1−(1+𝑖)−𝑡
𝑖
=
1−(1.1)−3
.1
=
.24868
.1
= 2.4868
PVCI = 50,000*2.4868 = 1,24,340
PVCO = 1,00,000 *1 = 1,00,000
NPV = 1,24,340 – 1,00,000 = 24,340
Title

7. Cont.
Ans. Tolerate Level if there is change in cash outlay
Company can tolerate the change in cash outlay till NPV greater than and
equal to zero.
Let change in cash outlay = x
NPV = PVCI – PVCO
0 = 1,24, 340 – x
X = 1,24,340
If increase in cash outlay by 24,340 (1,24,340-1,00,000) or less then
company can tolerate.
Tolerate level (%) for cash outlay = 24,340/1,00,000 = 24.34%

8. Cont.
Ans. Tolerate Level if there is Expected life of project
Company can tolerate the change in expected life of project till NPV greater
than and equal to zero.
Let change in expected life = x
NPV = PVCI – PVCO
0 = 50,000* PVAF (10%, x) – 1,00,000
1,00,000 = 50,000* PVAF (10%, x)
PVAF (10%, 2) = 1.7355  PVCI = 50,000* 1.7355 =86,775
PVAF (10%, 3) = 2.4868  PVCI = 50,000* 2.4868 = 1,24,340
It mean it acceptable when greater than 2 years and less than 3 years, now
we can use interpolation
2 +
1,00,000−86775
1,24,340 −86,775
* (3-2)  2.35 Years
Tolerate level for change in expected life of project = 3 years – 2.35 years =
.65 Years
Tolerate level (%) = .65 / 3 = 21.66%

9. Cont.
Ans. Tolerate Level if there is change in net cash flow
Company can tolerate the change in net cash flow till NPV greater than and
equal to zero.
Let change in net cash flow = x
NPV = PVCI – PVCO
0 = x* PVAF (10%,3) – 1,00,000
1,00,000 = x * 2.4868
X = 1,00,000/2.4868 = 40,212
Tolerate level If decrease in net cash flow by 9788 (50,000-40,212).
Tolerate level (%) for cash outlay = 9788 /50,000 = 19.576%

10. Cont.
Ans. Tolerate Level if there is change in Discount rate.
Company can tolerate the change in Discount rate till NPV greater than and
equal to zero.
Let change in Discount rate = x
NPV = PVCI – PVCO
0 = 50,000* PVAF (x,3) – 1,00,000
1,00,000 = 50,000* PVAF (x,3)
PVAF (x,3) = 2
PVAF (23%,3) =
1−(1.23)−3
.23
=
.46261
.23
= 2.011
PVAF (24%,3) =
1−(1.24)−3
.24
=
.47551
.24
= 1.981
It mean it acceptable when greater than 23 % and less than 24%, now we can
use interpolation
23 +
2−1.981
2.011−1.981
* (24-23)  23.63%
Tolerate level for discount rate = 13.63% (23.63%-10%)

11. Thank
s