termpaper on capital budgeting
TRANSCRIPT
Ans to exercise no.9
Solution:Project A:
Initial cost Tk 20000
Calculation of Net Cash Benefit
Year Cash Flow after Tax Depreciation NCB1 4000 2000 60002 4000 2000 60003 4000 2000 60004 4000 2000 60005 4000 2000 60006 4000 2000 60007 4000 2000 60008 4000 2000 60009 4000 2000 6000
10 4000 2000 6000 40000
As company follows straight line method of depreciationHere depreciation = 20000/10= Tk 2000 per year
ARR= Average Annual Net Profit X 100Average/Net Cash Outflow
= (40000/10) X 100 (20000+0)/2= 40%
At 14% cost of capital
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 20000
Cash Inflow A1 = A2 = A3 = A4 …….=A10= Tk6000K=14%=0.14NPV= A[1/K-1/K(1+K) n]-NCO= 6000[1/0.14-1/0.14 (1+0.14)10]-20000
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= 11297=+Ve
Internal Rate of Return (IRR).IRR= A+ C(B-A)
D
A=Lower Discounting RateB=Higher Discounting RateC= NPV at Lower Discounting RateD=Difference between the Net Present Value at Lower Discounting and Higher Discounting Rate
Calculation of NPV At 30% cost of capital
NPV=6000[1/0.30-1/0.30 (1+0.30)10]-20000
=(1451)= -Ve
IRR= 0.14+ 11297(0.30-0.14) (11297+1451)
= 0.28 = 28.18%
For project B
Initial cost Tk 30000
Calculation of Net Cash Benefit
Year Cash Flow after Tax Depreciation NCB1 6000 3000 90002 6000 3000 90003 6000 3000 90004 6000 3000 90005 6000 3000 90006 6000 3000 90007 6000 3000 90008 6000 3000 90009 6000 3000 9000
10 6000 3000 9000 60000
As company follows straight line method of depreciationHere depreciation = 30000/10= Tk 3000 per year
2
ARR= Average Annual Net Profit X 100Average/Net Cash Outflow
= (60000/10) X 100 (30000+0)/2= 40%
At 14% cost of capital
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 30000
Cash Inflow A1 = A2 = A3 = A4 …….=A10= Tk9000K=14%=0.14NPV= A[1/K-1/K(1+K) N]-NCO= 9000[1/0.14-1/0.14 (1+0.14)10]-30000= 16945 =+Ve
Internal Rate of Return (IRR).IRR= A+ C(B-A)
D
A=Lower Discounting RateB=Higher Discounting RateC= NPV at Lower Discounting RateD=Difference between the Net Present Value at Lower Discounting and Higher Discounting Rate
Calculation of NPV At 30% cost of capital
NPV=9000[1/0.30-1/0.30 (1+0.30)10]-30000
=(2176)= -Ve
IRR= 0.14+ 16945 (0.30-0.14 ) (16945+2176)
= 0.278 = 27.80%
Comments:
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At the given rate of return, the NPV of machine B is significantly higher than that of machine A. The ARR of the machines remain the same and machine A yields a little higher IRR than that of machine B. However, considering the significantly higher NPV of machine B, the company should choose machine B over the other one.
Ans to the exercise no. 10
Initial Cost Tk 250000Selling value Tk 40000Maintenance Cost per year Tk 25000
Calculation of Net Cash Benefit (NCB)
YearGross Cash Flow Depreciation
Maintenance Cost
Net Profit before Tax
Tax 40%
Net Profit after Tax NCB
Cum NCB
1 60000 42000 25000 (7000) 0 (7000) 35000 350002 75000 42000 25000 8000 3200 4800 46800 818003 90000 42000 25000 23000 9200 13800 55800 1376004 80000 42000 25000 13000 5200 7800 49800 1874005 70000 42000 25000 3000 1200 1800 43800 231200
40000 21200
As company follows straight line method of depreciationHere depreciation = (250000-40000)/5= Tk 42000 per year
At K=12% required rate of return
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 250000
Cash Inflow A1 A2 A3 A4 A5
35000 46800 55800 49800 43800
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NPV= [ 35000 + 46800+ 55800 + 49800 + 43800+40000 ] - 250000 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5
=(62525)= -Ve
Calculation of NPV At K=2% cost of capitalNPV= [ 35000 + 46800+ 55800 + 49800 + 43800+40000 ] - 250000
1.02 (1.02)2 (1.02)3 (1.02)4 (1.02)5
=3786= +Ve
IRR= 0.02+ 3786 (0.12-0.02 ) (3786+62525)
= 0.0257= 2.57%
Comments:Here, the IRR is much less than the given rate of return(12%). Besides, the NPV at the given rate of return is negative. Considering these facts, the project should not be approved.
Ans to the exercise no. 16
Machine A
Initial Cost Tk 60000Salvage value Tk 3000
Calculation of NCBYear Depreciation Annual Income after D & T NCB Cum NCB
1 11400 6300 17700 177002 11400 5400 16800 345003 11400 7300 18700 532004 11400 10000 21400 746005 11400 12000 23400 98000
41000
As company follows straight line method of depreciationHere depreciation = (60000-3000)/5= Tk 11400 per year
5
ARR= Average Annual Net Profit X 100Average/Net Cash Outflow
= (41000/5)X 100(60000+3000)/2
= 26.03%At Cost of Capital, K=12%
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 60000
Cash Inflow A1 A2 A3 A4 A5
17700 16800 18700 21400 23400
NPV= [ 17700 + 16800 + 18700 + 21400 + 23400+3000 ] - 60000 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5
= 11087= +Ve
At Cost of Capital, K=20%
NPV= [ 17700 + 16800 + 18700 + 21400 + 23400+3000 ] - 60000 1.20 (1.20)2 (1.20)3 (1.20)4 (1.20)5
= (1832)= -Ve
IRR= 0.12+ 11087 (0.20-0.12) (11087+1832)
= 0.1887= 18.87%
Machine B
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Initial Cost Tk 60000Salvage value Tk 3000
Calculation of NCBYear Depreciation Annual Income after D & T NCB Cum NCB
1 11400 12000 23400 234002 11400 10000 21400 448003 11400 8000 19400 642004 11400 5000 16400 806005 11400 6000 17400 98000
41000
As company follows straight line method of depreciationHere depreciation = (60000-3000)/5= Tk 11400 per year
ARR= Average Annual Net Profit X 100Average/Net Cash Outflow
= (41000/5)X 100(60000+3000)/2
= 26.03%
At Cost of Capital, K=12%
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 60000
Cash Inflow A1 A2 A3 A4 A5
23400 21400 19400 16400 23400
NPV= [ 23400 + 21400 + 19400 + 16400 + 17400+3000 ] - 60000 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5
= 13759= +Ve
At Cost of Capital,K=22%
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NPV= [ 23400 + 21400 + 19400 + 16400 + 17400+3000 ] - 60000 1.22 (1.22)2 (1.22)3 (1.22)4 (1.22)5
= (807)= -Ve
IRR= 0.12+ 13759 (0.22-0.12) (13759+807)
= 0.21
= 21.45%
Comments:Here, the two machines yield the same ARR and IRR. But the NPV of machine B is higher than that of machine A. Hence, Machine B should be chosen.
Ans to the exercise no. 19
For proposal A
Initial Cost Tk 100 LakhSalvage value Tk 10 Lakh
Calculation of NCBThe figures are in Lakh Tk
YearNet cash savings before D & T Depreciation
Net cash savings after depreciation before tax
Tax 40%
Net cash after D & T NCB
1 25 18 7 2.8 4.2 22.22 30 18 12 4.8 7.2 25.23 35 18 17 6.8 10.2 28.24 25 18 7 2.8 4.2 22.25 20 18 2 0.8 1.2 19.2
27.0
As company follows straight line method of depreciationHere depreciation = (100-10)/5= Tk 18 Lakh per year
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ARR= Average Annual Net Profit X 100Average/Net Cash Outflow
= (27/5)X 100(100+10)/2
= 9.82%
At Cost of Capital, K=12%
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 100 Lakh
The figures are in Lakh TkCash Inflow A1 A2 A3 A4 A5
22.2 25.2 28.2 22.2 19.2
NPV= [ 22.2 + 25.2 + 28.2 + 22.2 + 19.2+10 ] - 100 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5
= (9.34)Lakh= -Ve
At Cost of Capital,K=8%
NPV= [ 22.2 + 25.2 + 28.2 + 22.2 + 19.2+10 ] - 100 1.08 (1.08)2 (1.08)3 (1.08)4 (1.08)5
= 0.74Lakh= +Ve
IRR= 0.08+ 0.74 (0.12-0.08) (0.74+9.34)
= 0.0828
= 8.28%
For proposal B
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Initial Cost Tk 75 LakhSalvage value Tk 5 Lakh
Calculation of NCBThe figures are in lakh Tk
YearNet cash savings before D & T Depreciation
Net cash savings after depreciation before tax
Tax 40%
Net cash after D & T NCB
1 18 14 4 1.6 2.4 16.42 20 14 6 2.4 3.6 17.63 22 14 8 3.2 4.8 18.84 20 14 6 2.4 3.6 17.65 16 14 2 0.8 1.2 15.2
15.6
As company follows straight line method of depreciationHere depreciation = (75-5)/5= Tk 14 Lakh per year
ARR= Average Annual Net Profit X 100Average/Net Cash Outflow
= (15.6/5)X 100 (75+5)/2
= 7.8%
At Cost of Capital, K=12%
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ An ] - NCO1+K (1+K)2 (1+K)3 (1+K)n
NCO=Net Cash Outlay= TK 75Lakh
The figures are in Lakh TkCash Inflow A1 A2 A3 A4 A5
16.4 17.6 18.8 17.6 15.2
NPV= [ 16.4+ 17.6 + 18.8 + 17.6+ 15.2+5 ] – 75
10
1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5
= (10.30)Lakh= -Ve
At Cost of Capital,K=6%
NPV= [ 16.4+ 17.6 + 18.8 + 17.6+ 15.2+5 ] – 75 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5
= 0.96Lakh= +Ve
IRR= 0.06+ 0.96 (0.12-0.06) (0.96+10.30)
= 0.0649
= 6.49%
Comments:In this case, both of the NPVs are negative. Also, both of the IRRs are less than the given cost of capital. Therefore, none of the projects should be approved.
Ans to exercise no. 21
Project-X
Initial Cost Tk 250000
Calculation of NCB
Year Cash Flows1 600002 700003 750004 500005 400006 600007 30000
At Cost of Capital, K=12%
Net Present Value:
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NPV=[ A1 + A2 + A3 +…………………+ A7 ] - NCO1+K (1+K)2 (1+K)3 (1+K)7
NCO=Net Cash Outlay= TK 250000
Cash Inflow A1 A2 A3 A4 A5 A6 A7
60000 70000 75000 50000 40000 60000 30000
NPV= [ 60000+ 70000 + 75000 + 50000 + 40000 + 60000 + 30000 ]- 250000 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5 (1.12)6 (1.12)7
= 11199= +Ve
Project-Y
Initial Cost Tk 275000
Calculation of NCB
Year Cash Flows1 1000002 1200003 900004 800005 06 07 0
At Cost of Capital, K=12%
Net Present Value:
NPV=[ A1 + A2 + A3 +…………………+ A7 ] - NCO1+K (1+K)2 (1+K)3 (1+K)7
NCO=Net Cash Outlay= TK 275000
Cash Inflow A1 A2 A3 A4 A5 A6 A7
100000 120000 90000 80000 0 0 0
12
NPV= [ 100000+ 120000 + 90000 + 80000 + 0 + 0 + 0 ]- 275000 1.12 (1.12)2 (1.12)3 (1.12)4 (1.12)5 (1.12)6 (1.12)7
= 24850= +Ve
Comments:At the given cost of capital, NPVs of both of the projects are positive. But project Y yields a significantly higher NPV than project X. Therefore, project Y should be chosen.
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