Class Questions - Cap Budgeting

1. Equipment A has a cost of Rs. 75, 000 and a net cash flow of Rs.
20, 000 per

year for 6 years. A substitute equipment B would cost Rs. 50, 000 and
generate net cash flow of Rs. 14000 per year for 6 years. The required rate
of return for both equipments is 11%. Calculate the IRR and NPV for the
equipments. Which equipment should be accepted and why?
CASE
DPL is a fast growing profitable company. The company is situated in Gujarat. Its
sales are expected to grow about 3 times from Rs. 360 million in 2003 –04 to Rs.
1, 100 million in 2004 –05. The company is considering of commissioning a 35
km pipeline between two areas to carry gas to the state electricity board. The
project will cost Rs. 250 million. The pipeline will have a capacity of 2.5 MMSCM.
The company will enter into a contract with State Electricity Board to supply gas.
The revenue from the sale to SEB is expected to be Rs. 120 million per annum.
The pipeline will also be used for transportation of LNG to other users in the
area. This is expected to bring additional revenue of Rs. 80 million per annum.
The company management considers the useful life of the pipeline to be 20
years. The finance manager estimates cash profit to sales ratio of 20% per
annum for the first 12 years of the project operations and 17% per annum for the
remaining life of the project. The project has no salvage value. The project is in a
backward area is exempt from paying any taxes. The company requires a rate of
return of 15% from this project.
Q.2. Bharat Foods Limited is a consumer goods manufacturing company. It is

considering a proposal for marketing a new food product. The project will require
an investment of Rs. 1 million in plant and machinery. It is estimated that the
machinery is sold for Rs. 100, 000 at the end of its economic life of 6 years.
Assume that the loss or profit on the sale of machine is subject to the corporate
tax. The company can charge annual written down depreciation at 25% for the
purpose of tax computation. Assume that the company’s tax rate is 35% and the
discount rate is 18%. The following tables are also given:
Investment data
(Rs. In ‘000)
0 1 2 3 4 5 6
Year
Initial 1000
Investmen
t
Dep 250 188 141 105 79 59
Acc Dep 250 438 579 684 763 822
BV 1000 750 562 421 316 237 178
NWC 20 30 50 70 70 30 0
Total 1020 780 612 491 386 267 178
Salvage 100
Value
Summarized P & L
(Rs. In ‘000)
1 2 3 4 5 6
Year
Revenues 550 890 1840 2020 1680 1300
Expenses - 300 - 472 - 958 - 1075 - 890 - 680
Dep - 250 - 188 - 141 - 105 - 79 - 59
Taxable 0 230 741 840 711 561
Profit
Tax ( .35 ) 0 81 259 294 249 196
PAT 0 149 482 546 462 365
Q.3. Sandals Inc. is considering the purchase of a new leather cutting machinery
to replace an existing machine that has a Book Value of Rs. 3000/= and can be
sold for Rs. 1500/=. The estimated salvage value of the old machine in 4 years
would be zero and it is depreciated on a straight line basis. The new machinery
will reduce costs by Rs. 7000/year. The new machine has a 4 year life, costs Rs.
14000 and can be sold for an expected amount of Rs. 2000 at the end of the
fourth year. Assuming SLD and 40% tax rate, define the cash flows and check
the feasibility @ 10%.
Q.4. A Capital project involves the following outlays:
Plant and Machinery: Rs. 180 lakhs

Working Capital : Rs. 120 lakhs
The proposed scheme of financing is as follows:
Equity : Rs. 100 lakhs
L.T. Loans : Rs. 104 lakhs

Trade Credit: Rs. 36 lakhs
Commercial Banks : Rs. 60 lakhs
The project has a life of 5 years. Plant and Machinery are depreciated at the rate
of 15% per annum as per the WDV method. The expected annual net sales is
Rs. 350 lakhs. Cost of sales( including depreciation, but excluding interest) is
expected to be Rs. 190 lakhs per year. The tax rate is 60%. At the end of 5 years
Plant and Machinery will fetch a value equal to the Book Value and there will be a
full recovery of Working Capital. Short Term Advance from Commercial Bank will
be maintained at Rs. 60 lakhs and carry an interest of 18% per annum and it will
be fully liquidated. Trade Credit will be maintained at Rs. 36 lakhs and will be fully
paid at the end of the fifth year. Evaluate the project from the long term funds
suppliers point of view.
5. Television Limited is a highly profitable firm, it has a proposal for

manufacturing car televisons. The project would involve cost of plant of Rs. 500
lakhs, installation cost of Rs. 100 lakhs and working capital of 125 lakhs. The
annual capacity of the plant is to manufacture 20, 000 sets. The price per set in
the first year would be Rs. 12,000. The variable cost to sales ratio is expected to
be 65%. The fixed cost per annum would be Rs. 300 lakhs ( excluding
depreciation). The company would incur promotional expenditure of Rs. 120
lakhs in the first year. (Nominal Terms) Written down depreciation rate for the tax
purposes is 25%. Working capital requirements is estimated to be 25% of sales.
The company expects that the plant’s capacity utilisation over its economic life of
7 years will be as follows:
Year 1 2 3 4 5 6 7
Capacity 40 40 50 75 100 100 100
Utilisation
The terminal value of the project is expected to be 20% of its original cost. The
corporate tax rate is 35% and profit from the sale of asset is taxed as ordinary
income. The inflation rate is expected to be 5%.
Q.6. A project costs Rs. 6000 and it has cash inflows of Rs. 4000, Rs. 3000, Rs.
2000 and Rs.1000 in years through 1 – 4. Assume that the associated (Certainty
Equivalent) CE factors are Year 0 = 1.00, Year 1 = 0.90, Year 2 = 0.70, Year 3 =
0.50 and Year 4 = 0.30 and the risk free discount rate is 10%. What is the Net
Present Value? (Hint: Multiply each cash flow by CE and calculate NPV)
Q.7. The Finance Manager of a Food Processing company is considering the

installation of a plant costing Rs. 10 million to increase its processing capacity.
The expected value of the underlying variables are given in the table below.
Salvage value is assumed to be zero. Expected life is 7 years. Forecasts under
different assumptions are also given.
Expected Values of Variables
Investment ( Rs. In ‘000) 10, 000

Sales Volume (units ‘000) 1000
Unit Selling Price ( Rs.) 15
Unit Variable Cost (Rs.) 6.75
Annual Fixed costs ( Rs. ‘000) 4, 000
Depreciation ( WDV) 25%
Corporate Tax Rate 35%
Discount rate 12%
Forecast under different Assumptions
Variable Pessimistic Expected Optimistic

Volume ( units 750 1000 1250
‘000)
Unit Seling Price 12.75 15.00 16.50
( ‘000)
Units Variable 7.425 6.75 6.075
Cost (Rs.)
Annual Fixed 4, 800 4000 3, 200
Costs
Calculate NPV for each scenario.

Class Questions - Cap Budgeting

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1. Equipment A has a cost of Rs. 75, 000 and a net cash flow of Rs.

20, 000 per

Q.2. Bharat Foods Limited is a consumer goods manufacturing company. It is

Q.4. A Capital project involves the following outlays:

Plant and Machinery: Rs. 180 lakhs

The proposed scheme of financing is as follows:

Equity : Rs. 100 lakhs

L.T. Loans : Rs. 104 lakhs

5. Television Limited is a highly profitable firm, it has a proposal for

Q.7. The Finance Manager of a Food Processing company is considering the

Expected Values of Variables

Investment ( Rs. In ‘000) 10, 000

Variable Pessimistic Expected Optimistic

Calculate NPV for each scenario.

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