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- 1. Due date to submit November 2nd 2012 CAPITAL BUDGETINGTask 1 - 23 1. A company purchased an asset worth Rs. 10,00,000. The life of the asset is 5 years and each year, it generates a cash inflow of Rs. 3,50,000. Calculate pay- back period and post pay-back period. 2. A company is considering purchase of a machinery costing Rs. 15,00,000. It has a life of 6 years and its expected Profits after Tax are as follows: YEAR 1 2 3 4 5 6 P.A.T.(RS.) 2,00,000 5,00,000 3,00,000 3,00,000 2,00,000 1,00,000 3. An Engineering company is considering the purchase of a new machine for its immediate expansion programme. There are three possible machines at same cost which are suitable for the purpose, the details of which are given below: PARTICULARS MACHINE MACHINE MACHINE ONE (Rs.) TWO (Rs.) THREE(Rs.) Capital Cost 6,00,000 6,00,000 6,00,000 Cost of Production: Direct Material 40,000 50,000 48,000 Direct Labour 50,000 30,000 36,000 Factory overheads 60,000 50,000 58,000 Administration Cost 20,000 10,000 10,000 Selling and Distbn. Cost 10,000 10,000 10,000 Total 1,80,000 1,50,000 1,67,000 Sales per annum 5,00,000 4,00,000 4,50,000 The economic life of machine I is 4 years, while it is 6 years for the other two, after which they are expected to have a scrap value of Rs.80,000; Rs. 48,000 and Rs. 60,000 for machines I, II and III respectively. Sales are expected to be at the rates shown for each year during their full economic life. Total tax to be paid is estimated at 45% of net earnings each year. You are required to show which investment would be most profitable on the basis of pay-back period methd. 4. An oil company proposes to install a pipeline for transportation of crude oil from wells to refinery. Investment and operating cost of the pipeline vary for different sizes of pipes. The following details have been collected. 5. Diameter of the Pipe 3” 4” 5” 6” 7” Investment required 16 24 36 64 150 (in lakh rupees) Gross annual savingsDr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 1
- 2. Due date to submit November 2nd 2012 in operating cost before depreciation 5 8 15 30 50 (in lakh rupees) Estimated life of the installation (in years) 10 10 10 10 10 Taxation rate (%) 50 50 50 50 50 Calculate cash flow and on this basis indicate the proposal that has the shortest pay-back period. If the company desires a 15% after-tax return, recommend the largest pipeline to be installed. 6. The manager of AB Co. Ltd., is considering three mutually exclusive investment projects A, B and C each providing a cash flow of Rs. 20,000 p.a for an initial investment of Rs. 1,00,000. The useful lives are as follows: Project A – 5 years; Project B – 6 years; and Project C – 7 years. Advise the management regarding the choice of the project. 7. Two projects A and B each requiring an investment of Rs. 10,00,000 have an economic life of 4 years and 6 years respectively. The earnings from these 2 machines are expected to be as follows: YEAR MACHINE A (Rs.) MACHINE B (Rs.) 1 5,00,000 1,00,000 2 4,00,000 2,00,000 3 3,00,000 3,00,000 4 1,00,000 4,00,000 5 - 4,00,000 6 - 1,00,000 Which project is advisable on the basis of non-discounted cash flow techniques? 8. The Alpha Co. Ltd., is considering the purchase of a new machine. Two alternative machines A and B have been suggested, each costing Rs. 4,00,000. Earnings after tax, but before depreciation are expected to be as follows: YEAR MACHINE A (Rs.) MACHINE B (Rs.) 1 40,000 1,20,000 2 1,20,000 1,60,000 3 1,60,000 2,00,000 4 2,40,000 1,20,000 5 1,60,000 80,000Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 2
- 3. Due date to submit November 2nd 2012 The company has a target of 10% return on capital. Suggest the company as to the best alternative. 9. A project involves an investment of Rs. 10,00,000 and the amount has to be spent as follows: Beginning of first year Rs. 2,50,000 Beginning of second year Rs. 2,50,000 Beginning of third year Rs. 2,50,000 Beginning of fourth year Rs. 2,50,000 The project will give inflows as follows: First Year - Rs. 2,30,000 Second Year - Rs. 2,28,000 Third Year - Rs. 2,78,000 Fourth Year - Rs. 2,33,000 Fifth Year - Rs. 80,000 Calculate Net Present Value of the project assuming cost of capital as 10%. 10. X Ltd., has under consideration the following two projects. The details are as under: PARTICULARS PROJECT X PROJECT Y Investment in machinery Rs. 15,00,000 Rs. 10,00,000 Working Capital Rs. 5,00,000 Rs. 5,00,000 Life of machinery 6 years 4 years Scrap value of machinery 10% 10% Tax Rate 35% 35% Income Before Depreciation and Taxes: Rs. Rs. First Year 15,00,000 8,00,000 Second Year 9,00,000 8,00,000 Third Year 15,00,000 8,00,000 Fourth Year 8,00,000 8,00,000 Fifth Year 6,00,000 - Sixth Year 3,00,000 -Advise the company as to the best alternative using different techniques of capitalbudgeting. (Cost of Capital is 12%). 11. Using different techniques of capital budgeting advise WINE LTD., regarding selection of the best of the following two alternatives: PARTICULARS PROJECT X PROJECT Y Original Cost Rs. 56,125 Rs. 56,125 Net Working Capital Rs. 5,000 Rs. 6,000 Estimated Life 5 years 5 years Estimated salvage value Rs. 3,000 Rs. 3,000Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 3
- 4. Due date to submit November 2nd 2012 Income Tax Rate 35% 35% Annual Estimated Income After Depreciation and Taxes: Rs. Rs. Year 1 3,375 11,375 Year 2 5,375 9,375 Year 3 7,735 7,375 Year 4 9,375 5,375 Year 5 11,375 3,375 12. The Finance Manager of CD Ltd., is considering an investment project costing Rs. 3,00,000 and it will have a scrap value of Rs. 20,000 at the end of 5 years life. Transportation costs are expected to be Rs. 10,000 and installation cost Rs. 50,000. If the project is accepted spare parts inventory of Rs. 10,000 must also be acquired and maintained. It is estimated that the spare parts will have an estimated scrap value after 5 years amounting to 60% of their initial cost. Annual revenue from the project is expected to be Rs. 3,40,000 and annual labour, material and maintenance expenses are estimated to be Rs. 30,000; Rs. 1,00,000; and Rs. 10,000 respectively. The depreciation and taxes for each of the 5 years will be as follows: YEAR 1 2 3 4 5 Depreciation 1,44,000 86,400 64,800 43,200 1,600 (Rs.) Taxes (Rs.) 22,400 45,440 54,080 62,720 79,360 Calculate the cost of the project and cash inflows for each year and evaluate the project at 12% rate of interest. 13. A company has the choice of continuing making a product on the existing machine or obtaining one of the two alternatives in lieu of it. The following details are available: PARTICULARS PRESENT MACHINE E MACHINE F MACHINE (RS.) (RS.) Book Value 50,000 - - Resale Value 55,000 - - Purchase price - 90,000 1,00,000 Fixed cost per annum 45,000 54,000 66,000 (including depreciation) Variable running cost per unit (including labour) 1,50 0.75 1.25 Units produced per hour 8 8 12 Selling price per unit 10 10 10Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 4
- 5. Due date to submit November 2nd 2012 Additional Information: (a) Material cost per unit –Rs.5 (b) Annual working hours – 2000 (c) Life of each machine (as from now) – 5 years. (d) Residual value is negligible. (e) Depreciation is to be calculated by straight line method, using book value or purchase price as the case may be. (f) The sales manager believes that extra production from Machine F will need an extra expenditure of Rs. 4,000 on advertising to be sold in full. (g) Taxation rate may be assumed at 50% and the cost of finance is 9%. Evaluate the project using NPV Method. 14. Home Gadgets Co., is considering building and assembling plant. The decision has been narrowed down to two possibilities. The company desires to choose the best plant at a level of 10,000 gadgets per month. Both plants are expected to have a life of 10 years and no salvage value. The cost of capital is 10%. Assuming a zero income tax rate, suggest which would be the desirable choice. Cost of 10,000 gadgets per month output level PARTICULARS LARGE PLANT SMALL PLANT Initial Cost Rs. 30,00,000 Rs. 22,93,500 Direct Labour per annum: First Shift Rs.15,00,000 Rs. 7,80,000 Second Shift - Rs.9,00,000 Overheads per annum Rs. 2,40,000 Rs. 2,10,000 15. A company is faced with the problem of choosing between two mutually exclusive projects. Project A requires a cash outlay of Rs. 1,00,000 and cash running expenses of Rs. 35,000 per annum. On the other hand, Project B will cost Rs. 1,50,000 and requires a cash running expenses of Rs. 20,000 p.a. Both the machines have a 8 year life. Project A has Rs. 4,000 salvage value and Project B has Rs. 14,000 salvage value. The company’s tax rate is 50% and it has a 10% required rate of return. Assume depreciation on straight line basis. Which project should be accepted? 16. An investment of Rs. 1,38,500 yields the following cash inflow: YEAR 1 2 3 4 5 CASH INFLOW 30,000 40,000 60,000 30,000 20,000 (RS.) Find the Internal Rate of Return.Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 5
- 6. Due date to submit November 2nd 2012 17. A sole trader installs a machinery for the production of a luxury article, the demand for which is expected to last for only 5 years. The total capital put in by the trader is: Machinery Rs. 2,70,500 Working Capital Rs. 40,000 Rs. 3,10,500 The working capital will be fully realized at the end of the 5th year. The scrap value of the machinery to be realized at the end of 5th year is estimated at Rs. 5,500. The traders’ earnings are estimated to be as follows: YEAR 1 2 3 4 5 Profits before Depreciation 90,000 1,30,000 1,70,000 1,16,000 19,500 and Taxes (Rs.) Tax Payable 20,000 30,000 40,000 26,000 5,000 (Rs.) Calculate Internal Rate of Return. 18. X Ltd., proposes to invest Rs. 2,00,000 in a machinery the life of which is estimated to be 5 years. Profits from the project is as follows: YEAR 1 2 3 4 5 Profits before Depreciation 80,000 80,000 90,000 90,000 75,000 and Taxes (Rs.) The company follows reducing balance of depreciation and the rate of depreciation is 20%, the entire balance being written off in fifth year. Rate of taxation is 35%. What is the Internal Rate of Return? 19. A project costs an initial investment of Rs. 40,000 and is expected to generate annual cash inflow of Rs. 16,000 for 4 years. Calculate Internal Rate of Return. 20. A project costs Rs. 16,000 and is expected to generate cash inflows of Rs. 4,000 each year, for 5 years. Calculate Internal Rate of Return. 21. You are required to suggest which project would be more feasible if the cost of capital is 12% and the initial investment of both projects A and B is Rs. 15,00,000.Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 6
- 7. Due date to submit November 2nd 2012 YEAR INFLOW FROM INFLOW FROM PROJECT A (RS.) PROJECT B (RS.) 1 8,00,000 2,00,000 2 8,00,000 4,00,000 3 4,00,000 4,00,000 4 2,00,000 4,00,000 5 - 6,00,000 6 - 8,00,000 (including scrap) 22. Capro Industries plans an investment of Rs. 75,000 in new machinery that would produce inflow of Rs. 25,000 every year for 5 years. The representative of another equipment manufacturer presents an alternative proposal. By investing Rs. 1,60,000 in his company’s equipment Capro Industries can obtain a cash inflow of Rs. 50,000 every year for five years. In future, an investment of this type can be expected to yield a discounted rate of return of 12%. You are required to find: (a) which alternative is more attractive if a discounted rate of 12% is expected? (b) the discounted rate of return on investment alternatives, and (c) discounted rate of return on incremental investment. 23. Pyramid Ltd., is examining two mutually exclusive proposals for new capital investment. The data on the proposals are as follows: PARTICULARS PROJECT A PROJECT B Net Cash Outlays Rs. 40,000 Rs. 50,000 Salvage Value Nil Nil Estimated Life 4 years 5 years Income Tax Rate 50% 50% Cut-off rate for appraisal 10% 10% Earnings Before Depreciation and Taxes: Rs. Rs. Year 1 12,000 14,000 Year 2 14,000 16,000 Year 3 16,000 18,000 Year 4 22,000 22,000 Year 5 - 20,000 Using different techniques of capital budgeting, advise which proposal would be preferable.Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 7
- 8. Due date to submit November 2nd 2012Dr. S. Bhatt MBA, MFM, ACS, CFA, PGPM, PGDIR, MPhil., PhD, DBA (Swiss)drbhatt2006@gmail.com©with Dr. Bhatt Page 8

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