Capital Budgeting

A capital budgeting decision is faced by Sunrise manufacturing company. The company is planning to introduce a new product line requiring additional machine. The management must choose between two imported machines with same capital cost but different annual operating costs, operating lives, overheads and cash flow implications. Based on projected sales, operating costs, advertisement expenditure, depreciation, taxation and additional equipment requirements, the company evaluates the financial feasibility of the imported machine and identifies one of the most suitable machines in current scenario.

The company is planning to diversify its operations by launching a new product line. The decision to introduce the product is driven by changing market conditions, technological advancements and the need to remain competitive. The management team, led by the CEO and supported by the financial analyst, operations manager and marketing manager, undertakes a detailed evaluation of market demand, pricing strategy, desired quality product of additional output and production requirements. Due to fast changing technology, the expected life span of machine is not for longer period.

After carefully marketing the new product line and analysis of both the imported machines, the management team desires to consider the most profitable machine out of two imported machines.

The details of both the machines and expected sales revenue and cost associated with output from these machines are as follows :

On the basis of above facts given, you are required to calculate the most profitable investment option by following method :

(a)Average Accounting Rate of Return Method;

(b)Pay-back period Method;

(c)Equivalent Net Present Value Method;

(d)Determine Annual profit after tax and Annual Cash Flow after tax.

(ii)‘‘Capital Budgeting is important not only because of the high investment cost of capital projects, but also due to their irreversible nature, long-term commitment and impact on profitability.’’

Explain this statement and discuss the importance of capital budgeting.

(a)Rank the proposals A to D according to payback period. Which proposals can be accepted ?

(b)Rank the proposals A to D according to Present Value Index Method. Which proposals can be accepted ?

(i)NPV of gas pipeline bid for the Government Company. Give your recommendation regarding acceptability of the project.

(ii)Payback period, post payback profitability index and discounted payback period.

(iii)NPV of the Government project, after application of Certainty Coefficients.

Present Value Factors are given below :

X Ltd. is increasing its production capacity and buying a machine at the cost of ₹ 40,00,000 having a useful life of 5 years with the salvage value of ₹ 8,00,000. The full purchase value of machine can be financed by 20% loan repayable in 5 equal installments falling due at the end of each year. Calculate the approx. figure of interest payable for the 4th year :

(A)₹ 4,08,813

(B)₹ 2,21,813

(C)₹ 3,12,018

(D)₹ 5,63,568

Profitability index of Project ‘A’ is 1.20167 when its cash flow is discounted at 12%. Initial investment on project was ₹ 3,00,000. This project generates equal cash flow over the five years time. How much cash flow will be generated by the project each year ?

(A)₹ 80,000

(B)₹ 81,794

(C)₹ 1,00,000

(D)₹ 1,21,000

Which technique in capital budgeting is also described as “what to do when all else fail” technique?

(A)Simulation analysis

(B)Cash flow analysis

(C)Decision-tree analysis

(D)None of the above

The coefficient of variation of net present value measures the ..................

(A)Relative risk of the project

(B)Total risk of the project

(C)Highest expected value of net present value

(D)Market risk of the project

In case where capital availability is unlimited and the projects are not mutually exclusive, for the same cost of capital, following criterion is useful ?

(A)Profitability Index

(B)Net present value

(C)Internal Rate of Return

(D)Any of the above

A machine is expected to require an initial outlay of ₹ 3,50,000 with useful life of four years, straight line method of depreciation and scrap value of ₹ 30,000. If it generates CFAT of ₹ 1,10,000, ₹ 1,50,000, ₹ 1,75,000 and ₹ 1,40,000 respectively through years 1 to 4 and cost of capital and applicable income tax rates are 10% and 30% respectively, the NPV of the project will be ₹ :

(A)93,486

(B)1,00,935

(C)84,500

(D)1,21,425

What is the key factor that influence investment decisions ?

(A)Estimation of capital outlays and the future earnings of the proposed project focusing on the task of value engineering and market forecasting

(B)Availability of capital and considerations of cost of capital focusing attention on financial analysis

(C)A set of standards by which to select a project for implementation and maximizing returns therefrom focusing attention on logic and arithmetic

(D)All of the above

E Ltd. is considering an investment that will cost ₹ 80,000 and have a useful life of 4 years. During the first 2 years, the net incremental after-tax cash flows are ₹ 25,000 per year and for the last 2 years, they are ₹ 20,000 per year. What is the payback period for this investment ?

(A)4 years

(B)3.5 years

(C)3.2 years

(D)3 years

Payback period is primarily considered as the measure of project’s rather than its ........................... .....

(A)profitability, capital recovery

(B)profitability, liquidity

(C)capital recovery, profitability

(D)capital recovery, liquidity

Management is considering a ₹ 1,00,000 investments in a project with a 5 years life and no salvage value. If the total tax paid income from the project is expected to be ₹ 60,000 and recognition is given to effect of straight-line depreciation on the investment, the average rate of return (ARR) of the project is :

(A)12%

(B)24%

(C)60%

(D)30%

What is the internal rate of return for a project having cash flows of ₹ 40,000 per year for 10 years and a cost of ₹ 2,26,009 ?

(A)8%

(B)12%

(C)14%

(D)10%

Which of the following will not suggest for accepting of a project ?

(A)Net present value is greater than zero

(B)Internal Rate of Return is less than the cost of capital

(C)Profitability index is greater than unity

(D)All of the above

When operating under a single-period capital- rationing constraint, you may first want to try selecting projects by descending order of their ................... in order to give yourself the best chance to select the mix of projects that adds most to the firm value.

(A)Profitability Index (PI)

(B)Net Present Value (NPV)

(C)Internal Rate of Return (IRR)

(D)Payback Period (PBP)

A company is considering a project with initial outlay of ₹ 5,00,000. The project is expected to last for 5 years with salvage value of ₹ 78,000. It is expected to generate CFAT of ₹ 1,28,000 per annum during its life. If the cost of capital of the company is 12%, the approx. NPV of the project will be :

(A)₹ 5660 positive

(B)₹ 5660 negative

(C)Zero

(D)Cannot be determined

Assume that a firm has accurately calculated the net cash flows relating to an investment proposal. If the net present value of this proposal is greater than zero and the firm in not under the constraint of capital rationing, then the firm should :

(A)Calculate the IRR of this investment to be certain that the IRR is greater than the cost of capital

(B)Compare the profitability index of the investment to those of other possible investments

(C)Calculate the payback period to make certain that the initial cash outlay can be recovered within an appropriate period of time

(D)Accept the proposal, since the acceptance of value-creating investments should increase shareholder wealth

( a )An investor is considering purchase of a new investment for ₹ 15,00,000. The Investor has two options – Option M and Option N and their expected cash inflow are as below :

The investor has a target return of 12%. Risk premium rates are 3% for Investment Option M and 7% for Investment Option N.

Which investment should be preferred ?

Which among the following is not true ?

(A)Capital budgeting is the process of evaluating and selecting long-term investments that are in line with the goal of investors’ wealth maximization

(B)The common traditional capital budgeting techniques are Payback Period and Accounting Rate of Return

(C)Modified Internal Rate of Return (MIRR) is the discount rate that equates the present value of the expected cash inflows with the initial cash outflow

(D)All the above statements are true

A project has net cash flows of ₹ 11,000 per annum for four years. The Initial cash outflow is ₹ 34,000. Which of the following statement is correct concerning the project’s internal rate of return (IRR) ?

(A)The IRR is less than 10%

(B)The IRR is greater than 10%, but less than 13%

(C)The IRR is greater than 13%, but less than 15%

(D)The IRR is greater than or equal to 15%

Y Ltd. is considering a project which requires initial investment of ₹ 20,000. Cost of capital is 10%. Estimated cash flows after tax are as follows :

What is the project’s discounted payback period ?

(A)3 years & 6.52 months

(B)4 years & 2.32 months

(C)3 years & 10.27 months

(D)4 years & 8.25 months

Which of the following is a modern technique of capital budgeting ?

(A)Accounting Rate of Return

(B)Internal Rate of Return

(C)Modified Internal Rate of Return

(D)Discounted Pay-back Period

Profitability index of Project ₹ is 1.50 when its cash flow is discounted at 12%. Initial investment on project was ₹ 1,44,200. This project generates equal cash flow over the five year’s time. How much cash flow will be generated by the project each year ?

(A)50,000

(B)60,000

(C)52,615

(D)71,220

A professional kitchen is attempting to choose between gas and electricity for its main heat source. Once a choice is made, the kitchen intends to keep to that source indefinitely. Each gas oven has a net present value (NPV) of ₹ 60,000 over its useful life of 5 years. Each electric oven has an NPV of ₹ 75,000 over its useful life of 7 years. The cost of capital is 8%. Which should the kitchen choose and why ?

(A)Gas because its average NPV per year is higher than electric

(B)Electric because its NPV is higher than gas

(C)Gas because its equivalent annual benefit is higher

(D)Electric because its equivalent annual benefit is higher

The following data is available for Project A whose initial investment is ₹ 80,000 and salvage value after 5 years are ₹ 4,500.

What is the NPV of Project A if the Ke of the company is 10% ? Ignore taxation.

(A)₹ 9,622

(B)₹ 6,827.5

(C)₹ 7,500

(D)₹ 8,500

A project under consideration whose useful life is 4 years, will have no change in revenue but will save cost of ₹ 1,60,000 annually. It has IRR of 15%. What is the project cost i.e., initial investment ?

(A)₹ 10,66,667

(B)₹ 4,80,200

(C)₹ 5,32,800

(D)₹ 4,56,800

Initial capital cost ₹ 100 crores, Annual unit sales 1.25 crores, Selling Price ₹ 100 per unit. Variable cost ₹ 50 per unit, Fixed Cost 12.50 crores per year, Cost of capital is 6%. What will be approx. % change in NPV for 5% reduction in Sale Price per unit considering duration of the project is 3 years ? Ignore taxation and depreciation and assume no interest cost.

(A)49.66%

(B)24.81%

(C)4.96%

(D)12.58%

(b)Equipment A has a cost of ₹ 75,000 and net cash flow of ₹ 20,000 per year for six years. A substitute equipment B would cost ₹ 50,000 and generate net cash flow of ₹ 14,000 per year for six years. The required rate of return of both equipments is 11 per cent. Calculate :

Cash flows become logically comparable when they are appropriately adjusted for their difference in..................

(A)Timing and Return

(B)Timing and Risk

(C)Risk and uncertainty

(D)Return and uncertainty

In order to increase a given net present value from a given set of outflows and inflows, the discount rate should generally be :

(A)Increased

(B)Decreased

(C)Kept as it is

(D)None of the above is required

A company is considering investing in a project that will cost ₹ 3 lakh, will last for 5 years with straight line method o f depreciation and salvage value of ₹ 20,000. Annual NPAT expected from project is ₹ 60,000. The pay-back period of the project will be :

(A)5 years

(B)2.59 years

(C)2.50 years

(D)Cannot be determined with given information

Point out the FALSE statement in relation to MIRR method :

(A)Under MIRR method, all cash inflows are assumed to be reinvested at reinvestment rate

(B)This method of calculation eliminates the problem of multiple IRR for projects with abnormal cash flows

(C)A project can simultaneously have positive NPV & MIRR lower than the cost of capital

(D)None of the above

A project under consideration is expected to require ₹ 9 lakh of initial investment. Its expected life is 5 years and it is expected to generate Cash flow after tax (CFAT) of ₹ 2,82,500 through years 1 to 5. If the cutoff rate for decision making is 12%, the Internal Rate of Return of the project will lie in the range of :

(A)12% - 13%

(B)11% - 12%

(C)16% - 17%

(D)23% - 24%

A firm is considering a project requiring ₹ 3,00,000 with 7 years life and ₹ 55,000 salvage value. The project is expected to generate net profit before depreciation and tax of ₹ 1,20,000 per annum. If straight line method of depreciation is to be followed and applicable income tax rate is 20%, the Average Rate of Return (ARR) of the project will be :

(A)27.75%

(B)47.88%

(C)38.31%

(D)22.66%

Two projects are under consideration with following details : Project A will require initial ou tlay of ₹ 60,000, will last for 5 years and will generate annual CFAT of ₹ 20,000. Project B will require initial outlay of ₹ 90,000, will last for 5 years and will generate annual CFAT of ₹ 29,000. If the cost of capital of the company is 10%, which of the following statements is true regarding these projects ?

(A)Project A is better on the basis of NPV criteria, whereas project B is better on IRR criteria

(B)Project B is better on the basis of NPV criteria, whereas project A is better on IRR criteria

(C)Both the projects are indifferent and acceptable similarly on NPV and IRR criteria

(D)Both the projects shall be rejected on NPV and IRR criteria

Company A has an offer to invest in three projects – B, C and D. However, Company A has funds to invest in only one project. So, it decided to use the NPV method to decide on the project that it should invest in. Which project should the company invest in ? Following are the details : Project B – ₹ 56,000 (Initial Investment), Cash flows for year, 1, 2 and 3 resp. (₹ 25,000; ₹ 20,000; ₹ 15,000), Risk -free rate is 2%, while Risk premium is 5%. Project C – ₹ 68,000 (Initial Investment), Cash flows for year l, 2 and 3 resp. (₹ 32,000; ₹ 12,000; ₹ 35,000), Risk -free rate is 1.2%, while Risk premium is 4%. Project D – ₹ 85,000 (Initial Investment), Cash flows for year 1, 2 and 3 resp. (₹ 12,000; ₹ 30,000; ₹ 53,000), Risk -free rate is 3%, while Risk premium is 7%.

(A)Project B

(B)Project C

(C)Project D

(D)None of the above

Which one of the following statements is TRUE ?

(A)IRR method can tend to understate the relative attractiveness of superior investment projects when the opportunity cost of cash flows is below the IRR

(B)Selection solely according to the NPV criterion will tend to favor larger rather than smaller investment projects

(C)When NPV = 0, the IRR exceeds the cost of capital

(D)Use of the PI criterion is especially appropriate for larger firms with easy access to capital markets

EC Ltd., has an Economic Value addition of ₹ 40,000 as on 31st March, 2022. During the year, its net operating profit before tax is ₹ 72,00,000 and Weighted Average Cost of Capital is 12.5%. If the assessable tax rate of the company is 30%, the amount of capital employed would be :

(A)₹ 4,00,00,000

(B)₹ 3,76,00,000

(C)₹ 3,32,00,000

(D)₹ 2,67,46,000

A company has invested ₹ 7,00,000 in a project, ₹ 5,00,000 initially and remaining at the end of first year. It also invested ₹ 2,00,000 in working capital at the end of 2nd year, which released back by the end of project life of 5 years. The scrap value realized from project at the end was ₹ 1,50,000. The project generated Cash inflows of ₹ 2,00,000 p.a. through years 1 to 5. If the required rate of return is 12% p.a., the approx. NPV of the project is :

(A)₹ 81,500

(B)₹ 83,809

(C)₹ 44,217

(D)The project has a negative NPV

Pay-back Period method of capital budgeting is not suitable in which of the following circumstances ?

(A)Where the firm is more interested in quick recovery of funds than profitability

(B)Where the expected returns from the projects are highly uncertain

(C)Under conditions of political and economic pressures

(D)None of the above

A project has an outlay of ₹ 14,100 in the beginning. It generated annual cash flows of ₹ 4,500 during its useful life of 4 years. The Internal Rate of return of the project will be between :

(A)11% and 10%

(B)12% and 13%

(C)11% and 12%

(D)13% and 14%

The capital outlay on a project was ₹ 75,000. Assuming that it generated NPV of ₹ 765 at discount rate of 12% and NPV of ₹ (1162) at discount rate of 13%, its IRR will be :

(A)12.4%

(B)12.55%

(C)12.61%

(D)Cannot be determined

Which of the following is an important ingredient of project appraisal under normal conditions ?

(A)Accuracy of methods and measurements planned to be adopted is well adhered to

(B)Objectivity of the proposal is highlighted so as to keep off from the bias and prejudices

(C)Ensure the reliability of the data and projected statements

(D)All of the above

Capital Budgeting Decisions are of paramount importance for a business firm. Which of the following factors contributes significantly to this importance ?

(A)Impact on immediate future only

(B)Involves huge amount of scarce resources

(C)Reversibility

(D)All of the above

Which of the following techniques are traditional cash flow based techniques ?

(A)Accounting Rate of Return

(B)Pay Back Period

(C)Net Present Value

(D)All of the above

A project requires an initial outlay of ₹ 5 Lakh. It is expected to generate annual CFAT of ₹ 1,25,000 through its useful life of years 1 to 5 excluding the scrap value of ₹ 1 Lakh to be realized at the end of 5th year. The Internal Rate of Return (IRR) of the project will be in the range of :

(A)10%-11%

(B)11%-12%

(C)12%-13%

(D)13%-14%

Pay-back Period with constant annual cash flows is calculated as :

(A)Initial Investment/Annual Cash Flow

(B)Initial Investment * Annual cash flow

(C)Annual Cash Flow/Initial Investment

(D)None of the above

Payback period method can be successfully employed in which of the following circumstances ?

(A)Where the firm does not suffer from liquidity problem and is interested in analysing profitability

(B)Where project is certain in terms of risk, and return is a serious concern

(C)Where good returns have been estimated but uncertainty is high

(D)None of the above

Net present value is generally preferred over Internal Rate of Return (IRR) method because :

(A)It is comparatively simple to operate

(B)It does not suffer from limitations of multiple rates

(C)The reinvestment assumption under NPV method is more realistic

(D)All of the above

The capital budgeting techniques are :

(1)Payback period

(2)Average rate of return

(3)Net present value

(4)Internal rate of return

(5)Profitability index

Which of the above is discounted cash flow techniques ?

(A)3, 4 and 5

(B)3, 4 and 2

(C)1, 2 and 4

(D)2, 3 and 1

The initial investment a project requires ₹ 5,00,000, the expected annual cash inflow is ₹ 90,000 for ten years. Determine the pay back period.

(A)5 years and 9 months (Approx.)

(B)5 years and 4 months (Approx.)

(C)4 years and 7 months (Approx.)

(D)5 years and 7 months (Approx.)

The initial investment required for projects ‘A’ and ‘B’ is ₹ 1,00,000 each. The present value of future cash flows from the projects are ₹ 1,15,500 and ₹ 1,19,500 respectively. Calculate the Profitability Index (PI) of projects A and B.

(A)PI of A and B – 0.8658 and 0.8368

(B)PI of A and B – 1.155 and 1.195

(C)PI of A and B – 0.8368 and 0.8658

(D)PI of A and B – 1.195 and 1.155

Profitability Index method gives due consideration to the .................... .

(A)Time value of money

(B)Finance cost of investments

(C)Traditional value of money

(D)Cost and time value of money

ABC Ltd. has estimated cash inflow of year 1, 2 and 3 as ₹ 500 lakh, 1200 lakh and ₹ 1500 lakh respectively. The probability of success is 0.70, 0.65 and 0.75 respectively. The PV factor @ 10% for the year 1, 2 and 3 are 0.909, 0.826 and 0.751 respectively. Estimated initial investment is ₹ 1500 lakh. The expected NPV is :

(A)₹ 307.21 Lakh

(B)₹ 305.71 Lakh

(C)₹ 307.31 Lakh

(D)₹ 310.51 Lakh

In case of agricultural and rurral development projects generally the prescribed IRR for viability is :

(A)10% in India and other developing countries

(B)15% in India and other developing countries

(C)20% in India and other developing countries

(D)22.5% in India and other developing countries

GRI Co. Ltd., decided to invest in plant and machinery ₹ 650.00 lakh and life of asset estimated is 5 years. At the end of the fifth year estimated residual value 3.00 lakh and disposal expenses 1.00 lakh only. The estimated inflow ₹ 75, 90, 110, 125 and 140 lakh respectively and PVF @ 9% for the year 1-5 as (0.9174, 0.8417, 07722, 0.7084 and 0.6499 respectively). Calculate NPV.

(A)239.66

(B)(–) 239.66

(C)240.96

(D)– 240.96

ABC Ltd. has capital investment of ₹ 400 crores. After tax operating income is ₹ 45 crore and company has a cost of capital of 10%. Determine the ‘‘Economic Value’’ Added of the firm:

(A)₹ 2 Crore

(B)₹ 3 Crore

(C)₹ 4 Crore

(D)₹ 5 Crore

A company is considering a proposal to install either a semi-automatic or highly automatic machine. If the firm installs a semi-automatic machine it excludes the acceptance of proposal to install highly automatic machine. Which type of capital budgeting decision is this?

(A)Mutually exclusive decisions

(B)Independent decision

(C)Contingent decisions

(D)Rejectable decisions

Derive the formula for calculation of NPV if ‘NCF’ represents net cash flow, ‘K’ represents risk adjusted discount rate, ‘I’ represents initial investment, and ‘t’ represents time period:

NCF  n

(A)NPV= t  0 (1  k) t  I NCF  n – O

(B)NPV = t  n (1  k) t NCF  n – I

(C)NPV = t  0 (1  k) t NCF  n I –

(D)NPV = t  0 (1  k) t - 1

A profitability index of 0.90 for a project means :

(A)The present value of benefits is 90% greater than the project’s costs

(B)The project’s NPV is positive

(C)The project returns 90 cents in present value for each current rupee invested

(D)The payback period is less than two years

Which of the following statements is correct ?

(A)If the NPV of a project is greater than 0, its PI will be negative

(B)If the IRR of a project is 0%, its NPV, using a discount rate, k, greater than 0, will be 0

(C)If the PI of a project is less than 1, its NPV should be negative

(D)If the IRR of a project is greater than the discount rate, k, its PI will be less than 1 and its NPV will be greater than 0

If the cut off rate of a project is lower than IRR, we may :

(A)Accept the proposal

(B)Reject the proposal

(C)Be neutral about it

(D)Wait for the IRR to increase and match the cut off rate

The re-investment assumption in the case of IRR technique assumes :

(A)Cash flows can be re-invested at the project IRR

(B)Cash flows can be re-invested at the weighted cost of capital

(C)Cash flows can be re-invested at the marginal cost of capital

(D)None of the above

For a Project, the cost benefit ratio is equal to one, then :

(A)IRR will be greater than one

(B)IRR will be greater than discount rate

(C)IRR will be lesser than discount rate

(D)IRR will be equal to discount rate

In a capital budgeting decision, incremental cash flows mean :

(A)Cash flows which are increasing

(B)Cash flows occurring over a period of time

(C)Cash flows directly related to the project

(D)Difference between cash inflows and outflows for each and every expenditure

Shaktiman Inc. considering a project that requires ₹ 4 Crore as initial investment. It is expected to generate annual after-tax cash flows of ₹ 60 Lakh for 12 years. Shaktiman’s weighted average cost of capital (WACC) is 14%. This project’s net present value (NPV) and the approximate internal rate of return (IRR) are :

NPV IRR

(A)60,40,000 10%

(B)60,40,000 14%

(C)62,10,000 14%

(D)62,10,000 10%

Mohan Pizza Ltd. is considering purchasing of a Pizza Oven. The expected purchase price is ₹ 2,70,000, expected annual revenues from the oven is ? 1,50,000, and expected annual costs are ₹ 90,000, including ₹ 22,500 of depreciation. The investment has a payback period of approximately :

(A)2.3 years

(B)4.2 years

(C)3.3 years

(D)4.5 years

A capital budgeting technique which does not require the computation of cost of capital for decision making purposes is,

(A)Net Present Value method

(B)Internal Rate of Return method

(C)Modified Internal Rate of Return method

(D)Pay back Period Method

MNP Ltd. is considering purchasing of an Asset costing ₹ 80,000 and having a useful life of 4 years. During the first 2 years, the net incremental after-tax cash flows are ₹ 25,000 per annum and for the last two years ₹ 20,000 per annum. What is the Payback period for this investment ?

(A)3.2 years

(B)3.5 years

(C)4.0 years

(D)Cannot be determined from this information

ABC project has the following cash inflows for 4 years as ₹ 34,444; ₹ 39,877; ₹ 25,000; and ₹ 52,800 respectively. The initial Investment is ₹ 1,04,000. Find the correct statement from the following :

Present value of an annuity of rupee one on various discounting factor in 4th year is :

(A)The IRR is less than 9%.

(B)The IRR is greater than or equal to 9%, but less than 13%.

(C)The IRR is greater than 16%, but less than 18%.

(D)The IRR is greater than or equal to 17%.

A firm expects an NPV of ₹ 8,000 if the economy is exceptionally strong (30% probability), an NPV of ₹ 4,000 if the economy is normal (40% probability), and an NPV of ₹ 2,000 if the economy is exceptionally weak (30% probability). Expected Net present value is ............ .

(A)₹ 5,200

(B)₹ 6,000

(C)₹ 5,000

(D)₹ 4,600

Find the correct statements regarding the risk-adjusted discount rate (RADR) approach ?

(A)Under the RADR approach, we should accept a project if its net present value (NPV) calculated using a risk-adjusted discount rate is positive.

(B)Adjusting the firm’s overall cost of capital upward is required if the project or group are of higher than average risk.

(C)Under the RADR approach, we would still compare a project’s internal rate of return (IRR) to the firm’s overall weighted-average cost of capital in order to decide acceptance/rejection.

(D)Adjusting the firm’s overall cost of capital downward is required if the project or group are of lower than average risk.

Which of the following are not applicable in the case of Payback period calculation of investment appraisal ?

(A)It is simple in concept and application.

(B)It favours only those projects that generate substantial inflows in the earlier years.

(C)The cut-off period is chosen arbitrarily.

(D)It considers the time value of money.

Firm A is considering a project A. The project involves cash outlay of ₹ 50,000 (t = 0), working capital outlay of ₹ 20,000 (t = 2), and is expected to generate Cash Flow After Tax (CFAT) of ₹ 12,000 per annum for 5 years excluding working capital release back and terminal value of 20%. What would be your advice to the company using Net Present Value approach, if its cost of capital is 10% ?

(A)Accept the project.

(B)Either Accept or Reject it as NPV is zero.

(C)Reject the project.

(D)Information incomplete.

(i)Roma Ltd. has to choose one of the machines from two mutually exclusive machines.

Two proposals are : Machine Rani and Machine Prince. The required amount of cash outlays for Machine Rani is ₹ 8,35,000; while for Machine Prince is ₹ 9,00,000. The current rate of yield on Government of India's bond is 7%, and the management is of the opinion to use the same as discount rate. The expected net cash inflows by deployment of both the machines are as under :

Amount ( ₹ )

You have to advise the management with respect to selection of either Machine Rani or Machine Prince. The Present value interest factor for the year 1, 2 and 3 are 0.9346, 0.8734 and 0.8163 respectively, for 7% discount rate.

(d)Calculate the Accounting Rate of Return (ARR) and rank the machine accordingly:

Machine has to be written off over a period of 5 years by straight line method.

(ii)Rank the following three proposals on the basis of net present value index method :

The present values of the annuity of ₹ 1 for 5, 6 and 10 years at 10% discount rate are ₹ 3.791, ₹ 4.335 and ₹ 6.145 respectively. Similarly the present values of ₹ 1 to be received at the end of fifth, sixth and tenth year at 10% discount rate are ₹ .621, ₹ .564 and ₹ .386 respectively.

(c)‘Capital Budgeting’ and ‘Capital Rationing’.

(b)X Ltd. has a machine having an additional life of 5 years, which costs ₹ 2,00,000 and has a book value of ₹ 80,000. A new machine costing ₹ 4,00,000 is available. Though its capacity is the same as that of the old machine, it will mean a saving in variable costs to the extent of ₹ 1,40,000 per annum. The life of the machine will be 5 years at the end of which it will have a scrap value of ₹ 40,000. The rate of income tax is 46% and it is the policy of the company not to make an investment if the yield is less than 12% per annum. The old machine, if sold today, will realise ₹ 20,000; and will have no salvage value if sold at the end of 5th year. Advise X Ltd. whether or not the old machine should be replaced. Assume capital gain to be tax free and ignore income tax saving on depreciation as well as on loss due to sale of existing machine.

(d)Calculate Market Value Added of Zinc Ltd., from the following information :

Assume market value of debt equals its book value.

ABC Ltd. whose shareholder ’s equity amounts to ₹ 10,00,000. The company owns 4,000 preferred shares and 1,50,000 common shares. The present market value for the common shares is ₹ 12 per share and ₹ 100 per share for the preferred stock.

Calculate total market value of shares and

Market Value Added in ₹ .

(A)Total market value of shares 18,00,000 and Market Value Added 10,00,000

(B)Total market value of shares 15,00,000 and Market Value Added 12,00,000

(C)Total market value of shares 22,00,000 and Market Value Added 12,00,000

(D)Total market value of shares 22,00,000 and Market Value Added 10,00,000

Net operating profit after tax is ₹ 20,00,000. Total capital employed is ₹ 1,50,00,000. Expected return on total capital employed ₹ 15,00,000.

Calculate Economic Value Added in ₹ .

(A)10,00,000

(B)15,00,000

(C)20,00,000

(D)5,00,000

Metadex Ltd. is a clean-tech start-up focused on affordable solar energy solutions for urban households. Founded by two engineers, Amit and Sumit, in 2021, the company developed a new solar panel design that is highly efficient and affordable. The journey begins with Amit, an engineer working in a traditional energy company. For years, Amit had seen the damaging environmental impact of fossil fuels and the inefficiency of the power grid. Concerned about climate change and driven by the desire to make a difference, he started researching alternative energy solutions. Solar energy stood out as an abundant and clean source of power that remained underutilized, especially in underserved communities. In 2020, Amit quit his job and partnered with his college friend—Sumit, an expert in renewable energy policy and a software engineer. Their vision is to revolutionize the energy industry by making solar power accessible to middle-income families across the globe.

Starting the company was tough. The team faced numerous challenges, including high upfront costs for solar panels, stiff competition from larger energy companies, and difficulties in navigating government regulations. They initially struggled to secure funding, as many investors were sceptical of renewable energy start-up, thinking the market was oversaturated or too slow to provide returns.

Early-stage solar hardware companies often require significant capital for research, development, and manufacturing, making it a tough sell to investors looking for faster returns. The company navigated through the initial stages of challenges. They developed a robust marketing plan to target eco-conscious communities, partnering with influencers in the sustainability space and running ads on social media. The team scaled their operations by working with local solar panel manufacturers, reducing costs, and creating jobs in the communities they served.

Currently in the expansion process, Metadex needed around ₹ 15 lacs to scale up production and penetrate further in the market. Amit and Sumit decided to explore alternative fundraising options that would allow them to keep control of their company and align with their longt erm vision.

The firm’s condensed Balance sheet for the current year is as follows :

Currently Earnings Before Interest and Tax (EBIT) = ₹ 8,00,000. Tax Rate 50%. Current Market Price per equity share ₹ 25, market value of debt equals its book value and cost of equity is 14%.

The financial advisors of Metadex Ltd. is assigned the task to calculate :

(i)the value of the firm and overall cost of capital before infusion of funds.

(ii)the Economic Value Added and Market Value Added.

The company has proposed to issue 8% 5000 Preference shares of ₹ 100 each and for the balance ₹ 10 lacs, it is considering two alternatives.

Alternative 1 : Raise 90% of funds required by issuing equity shares at current market price and the remaining by issuing 8% redeemable Debentures of ₹ 100 at par.

Alternative 2 : Raise 80% of the funds by issuing 9% Debentures of ₹ 100 at par and redeemable at a premium of 10% after 10 years and the balance by issuing Equity shares at 33.3333% premium.

Again, the financial advisor is asked to :

(i)Draft the final Capital Structure

(ii)Calculate the Earnings Per Share and Financial Leverage.

.............. represents the economic profits generated by a business above and beyond the minimum return required by all providers of capital.

(A)Shareholder Value Added (SVA)

(B)Economic Value Added (EVA)

(C)Market Value Added (MVA)

(D)Debenture-holders Value Added (DVA)

Economic Value Added (EVA) is :

(A)‘‘Net Operating Profit after Taxes’’– (Equity Capital × % Cost of Equity Capital)

(B)‘‘Net Operating Profit before Taxes ’– (Equity Capital × % Cost of Equity Capital)

(C)‘‘Net Operating Profit after Taxes’’– (Equity & Pref. Capital × % Cost of Equity Capital)

(D)‘‘Net Operating Profit before Taxes ’– (Equity & Pref. Capital × % Cost of Equity Capital)

(iv)What is Economic Value Added and Market Value Added ? Under what conditions will EVA increase ?

Which one of the following is not a corrective measure to improve Economic Value Added (EVA) ?

(A)Reducing the asset-turnover ratio

(B)Selling out the under-utilised assets

(C)Redeploying the capital invested to projects having higher operating performance

(D)All the above

The following details are given for painting decision of a car manufacturing company : Net operating profit before interest and tax ₹ 80 crores

Equity capital employed ₹ 100 crores 10% Debentures ₹ 40 crores

Weighted Average Cost of Capital 11% If tax rate is 30%, the Economic Value Added (EVA) is :

(A)₹ 76 crores

(B)₹ 53.2 crores

(C)₹ 37.8 crores

(D)₹ 15.4 crores

RR Ltd. in its capital structure has 1,00,000 equity shares of ₹ 10 each and 5000 preference shares of ₹ 100 each. At present the market value of equity shares is ₹ 16 and preference share is ₹ 120. In this case, the Market Value Added (MVA) is :

(A)₹ 6,00,000

(B)₹ 12,00,000

(C)₹ 16,00,000

(D)₹ 22,00,000

If Market Value Added (MVA) is positive, it states that the market-to-book ratio is :

(A)Zero

(B)More than one

(C)Less than one

(D)Infinity

(Net Operating Profit after Taxes) – (Equity Capital × % Cost of Equity Capital) is the formula of...................

(A)SVA

(B)MVA

(C)EVA

(D)CAPM

........................ represents the economic profits generated by a business above and beyond the minimum return required by all the providers of capital.

(A)Economic Value Added

(B)Arbitrage Pricing Theory

(C)Shareholders Value Added

(D)Market Value Added

Which of the following is true from the perspective of calculating Market Value Added ?

(A)MVA is a calculation that shows the difference between the market value of the company and capital contributed by all the investors

(B)MVA is a calculation that shows the difference between the market value of the company and capital contributed by all the shareholders

(C)MVA is a calculation that shows the difference between the market value of the company and capital contributed by all the equity shareholders

(D)All the above are incorrect

.............. is the most suitable method assessing projects in those circumstances where availability of resources is not a constraint.

(A)Pay Back Period method

(B)Net Present Value

(C)EVA Method

(D)MVA Method

The current capital invested in a company is ₹ 60 Lakh. Its post - tax net operating profit is ₹ 15 Lakh. Applicable income tax rate is 30%. If the opportunity cost of investment is 12%, the amount of Economic Value Added will be ₹ :

(A)3,30,000

(B)7,80,000

(C)10,50,000

(D)7,20,000

The most important traditional performance measure for shareholder value creation is :

(A)Earnings per share

(B)Shareholder value added

(C)Economic value added

(D)Market value added

Which of the following is a corrective measure to increase the Economic Value Added of a business concern ?

(A)Introduction of higher cost debt instead of lower cost equity

(B)Increase Asset Turnover Ratio

(C)Generate more revenue using more capital

(D)All of the above

The total amount of shareholders' equity of a company is ₹ 1,50,00,000. It owns 20000 preference shares of ₹ 100 each and 5,00,000 equity shares of ₹ 20 each. The current market price of equity shares is ₹ 35 each and that of preference shares is ₹ 110. The Aggregate of ‘‘Market Value Added" of the company is :

(A)₹ 25,00,000

(B)₹ 47,00,000

(C)₹ 20,00,000

(D)₹ 27,00,000

Excess of Company’s total market value over Capital invested is .....................

(A)Gross Value Added

(B)Economic Value Added

(C)Market Value Added

(D)Net Value Added

The opportunity cost of the equity capital invested in a business is considered in the computation of .................. .

(A)Shareholder value added

(B)Market value added

(C)Economic value added

(D)Gross value added

Economic Value added can be calculated as :

(A)Gross Operating Profit – Taxes – Cost of Capital

(B)Operating Profit – Taxes

(C)Net Operating Profit – Taxes – Cost of Capital

(D)None of the above

The goal of Economic Value Added (EVA) is to take into account the ......................... in the company.

(A)Cost of investments

(B)Cost of insurance

(C)Cost of capital invested

(D)Cost of non-service capital invested

From the following calculate Enomic Value Added (EVA) : Capital invested ₹ 50,000; operating profit after tax 20,000; opportunity cost is 10%.

(A)₹ 15,000

(B)₹ 20,000

(C)₹ 30,000

(D)₹ 50,000

If we add ‘Cost of Capital’ to ‘Economic Value Added’ we get .....................

(A)Profit After Tax

(B)Net Operating Profit After Tax

(C)Gross Value Added

(D)Earnings before Interest and tax

Rishabh Ltd. earns a profit after tax ₹ 3,96,000. Corporate tax is 0.4. Its capital structure consists of equity shares ₹ 9,60,000; 15% Term Loan ₹ 4,80,000; Cost of equity is 0.12. Its economic value added is ............

(A)₹ 2,66,400

(B)₹ 2,80,800

(C)₹ 2,08,800

(D)₹ 2,80,008

Market Value Added is :

(A)= Market Value of equity – Book value of equity

(B)= Present value of all future EVA

(C)= Shareholder Value Added (SVA)

(D)= Both (A) and (B)

From which of the following, Economic Value Added (EVA) will not increase :

(A)Operating profits grow without employing additional capital

(B)Unproductive capital is liquidated

(C)Cash flow generated by a business equal to the cost of the capital

(D)Additional capital is invested in the projects, that give higher returns than the cost of procuring new capital

The difference between the Company’s total market value and Capital invested is a :

(A)Economic Value Added (EVA)

(B)Shareholder Value Added

(C)Market Value Added

(D)Gross Value Added

(ii)From the following information, work out the Economic Value Added by Vije Ltd.:

The average rate of return expected by shareholders' from similar types of companies is 20%. Risk free rate is 10%, and corporate tax rate applicable for Vije Ltd. is 30%.

(iii)Explain the advantages of Economic Value Added (EVA) Analysis in the corporate world.

(c)Calculate coefficient of Variation for Proposal X and Proposal Y.

(d)Which proposal is riskier and which proposal should be accepted ?

A project has expected NPV of ₹ 1,83,000. Its coefficient of variation is 0.07377. Risk free rate is 8% and cost of capital is 10%. What is the standard deviation of project ?

(A)15,000

(B)12,000

(C)13,500

(D)13,334

Which of the following is correct formula to calculate coefficient of variation ?

(A)Correlation * SD/Expected NP

(B)Standard deviation * Expected Value of Cash Flow

(C)Standard Deviation/Expected Value of Cash Flow

(D)None of the above

Which technique is used to determine that how varying assumptions will affect the measures of investment worth ?

(A)Cash Flow Analysis

(B)Probability Analysis

(C)Risk Adjusted Rate of Return

(D)Sensitivity Analysis

(iii)Define Risk Adjusted Discount Rate and Certainty Equivalent Technique.

Raja & Co. desires to take a project whose cost is ₹ 10,000 and useful life is 4 years. Expected annual cash flows are 4,000 p.a. Cost of capital is 14%. The sensitivity of the project (in terms of percentage) will be :

(A)16.55%

(B)16.95%

(C)17.55%

(D)17.95%

In Risk-Adjusted Discount Rate method, ........................ is adjusted.

(A)Cash Inflows

(B)Cash Outflows

(C)Project duration

(D)None of the above

................ analysis takes care of only one or two variables which is at times inadequate. This limitation is partially overcome by what is known as .................. analysis, where ................. of certain prices, cost and other variables are created and the financial parameters are computed.

(A)Scenario, Sensitivity, Sensitivity

(B)Scenario, Sensitivity, Risk Analysis

(C)Sensitivity, Scenario, Scenario

(D)Risk, Scenario, Sensitivity

Risk Adjusted Discount Rate (RADR) is :

(A)Risk free rate minus risk premium

(B)Risk free rate plus risk premium

(C)Risk free rate multiplied by risk premium

(D)Risk free rate divided by risk premium

Many companies are forced to reduce spending when they are going to raise additional capital by issuing new debt or equity. This is an example of ...................

(A)Hard capital rationing

(B)Soft capital rationing

(C)Flexible capital rationing

(D)Internal Capital rationing