Capital Budgeting – Numerical Problems for Practice

The "Big Question" (15 Marks) in exams usually involves calculating NPV for a 5-year project.

The Problem

Question: XYZ Ltd plans to set up a plant.

• Initial Investment: ₹ 1,00,000.
• Life: 5 Years.
• Scrap Value: ₹ 10,000.
• Annual Sales: ₹ 80,000.
• Annual Variable Cost: ₹ 30,000.
• Fixed Cost: ₹ 10,000 (excluding Depreciation).
• Tax Rate: 30%.
• Cost of Capital (k): 10%.
• Calculate NPV.

The Solution

Step 1: Calculate Annual Cash Flow (CFAT)

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Step 2: Calculate PV of Inflows

• Annuity Factor for 10% for 5 years = 3.791.
• PV of Operating Inflows = 33,400 * 3.791 = 1,26,619.
• PV of Scrap Value (Received at end of Year 5):
  • Value = 10,000.
  • PV Factor (Year 5) = 0.621.
  • PV = 10,000 * 0.621 = 6,210.
• Total PV of Inflows = 1,26,619 + 6,210 = 1,32,829.

Step 3: Calculate NPV

• NPV = PV Inflows - Initial Investment
• NPV = 1,32,829 - 1,00,000
• Answer: NPV = + ₹ 32,829. (Accept the project).

Exam Notes: Common Mistakes

1. Depreciation: Students forget to add back depreciation at the end. Remember: Tax is calculated after depreciation, but Cash Flow includes depreciation.
2. Scrap Value: Often forgotten. It is an inflow in the last year. Discount it using the single year factor, not annuity factor.
3. Working Capital: If Working Capital is introduced at start, it is an Outflow. It is usually recovered at the end (Inflow).

Quiz Time! 🎯

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