Capital Budgeting Forumala

8/6/2019 Capital Budgeting Forumala

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CAPITAL BUDGETING

Under this technique of finance we are using the following methods to evaluate

the project with a various method like pay bank period, expected return, the time value of

money etc.

The method of Capital Budgeting are as under:-

1. Pay Back Period Method

2. Average Rate of Return Method

3. Net Present Value Method.

4. Internal Rate of Return Method.

The details and applicable formula of the described methods are as under: -

Pay Back Period Method: -

A. Pay Back Period = Investments of project / Cash in flows

Note: -

1. Investments of Project mean the cost of project.

2. Cash inflows can be calculated from following format.

Detail of Items Amount

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Sales Value -----------

Less: - Total Cost (Fixed cost & Variable Cost) ---------

Profit ----------

Less Depreciation ----------

Profit After Depreciation -----------

Less Tax ----------Profit After Depreciation and Tax ----------

Add Depreciation ----------

Profit after Tax but before Depreciation / Cash inflow ----------------

Note: -

Depreciation = Cost of assets Scrap Value / Life of Assets.

Or

Cost of Assets x Rate of Depreciation / 100

Amount of Tax = Profit After Depreciation x Rate of Tax / 100

If the Rate of Tax is not specified that it will be 50% assumed.

3. If in the question the unequal cash inflows are given than their CUMULATIVE

FREQUENCY is to be created, than pay back period will be calculated as like the

calculation of median in statistics.

B. Post Pay Profitability

Total Cash inflow in life of the project Cost of the investment

Note: -

Cost of the Investment = Cost of Investment Scrape value of the Investment

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2. Average Rate of Return Method (ARR): -

A.R.R. = Average profit after Tax / Average Investment x 100

Note: -

Average Investment = Investments value of the project + Scrape Value / 2

Average Profit After Tax = Profit After Tax / Life of the Project

3. Net Present Value Method: -

N.P.V.= Total Present Value of the Project Cost of the Investment

Note: -

N.P.V. = Cash inflow of the project x P.V. Factor of the project

Cash inflows = Profit after Tax but before Depreciation.

P.V. Factor = It is a value which is calculated on the basis of some

discounted Rate.

Net present value Index: - N.P.V. / Investment value

Present Value Index: - Total Present Value / Investment value

4. Internal Rate of Return Method.

I.R.R. = L.D.R. + P1 -o/ P1 - P2 x (H.D.R. L.D.R.)

Note: -

L.D.R. = Lower Discount Rate

H.D.R. = Higher Discount Rate

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P1 = Present value of cash in flow at L.D.R. (Cash inflow x P.V.

Factor of L.D.R.)

P2 = Present value of cash flow at H.D.R. (Cash inflow x P.V. Factor

of H.D.R.)

O = Investment Value of the Project.

The calculation of L.D.R. and H.D.R. is based on pay back period

method. Means first pay back period calculation is required and

according than consult the P.V. factor list.

ASSIGNMENT OF CAPITAL BUDGETING

1. A ltd. wants to invest the 10,00,000 Rs in a project; it will be considerable if it

returns the investment money in 13 years. The Fixed Cost of the project is

30,000 Rs and the Variable cost per unit 25 Rs per units. The sales volume

can be expected 50 Rs per unit. The production capacity of the project is

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10000 units. The Scrape value of the project can be estimated 1,00,000 Rs and

its life can be valued 10 years. The assume tax rate is 50%.

2. Following Cash in flows are available for Project A.

Calculate the Pay Back period method for Project A and also calculate the

post pay back profitability. Scrape value of the cost of the project is 20,000

Rs.

Year Cash Inflow (Rs)

0 1,50,000

1 20,000

2 50,000

3 60,000

4 40,000

5 65,000

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3. Profit of two project Tata Nagar and Singur are Rs 15,000,00 and Rs

20,00,000 Rs Respectively. The cost of both projects was Rs 80 Lacks. The

life the projects are 20 years can be estimated. The assume tax rate is 50%.

Calculate the Pay Back Period and Average Rate of Return for both the

projects and also indicate that which project is more profitable for the Tata

group of industry.

4. Profit after tax of a plant is 35,000 Rs. The cost of the plant was 100,000 Rs,

scrape value can be estimated after the 10 year of life 15,000 Rs. Calculate the

pay back period and Average rate of return method. The tax rate is 50%.

5. The cost of a plant is Rs 500,000. The Depreciation rate is 10% on the cost of

plant. The profit after tax but before depreciation of the plant can be expected

for first three years is 2,40,000 Rs and 3,00,000 and 120,000 Rs respectively.

The assume tax rate is 50%.

Calculate the following: -

Pay bank period method.

Average rate of return method

Calculate the Net Present value of the project for 10% rate of discount.

The P.V. Factor at 10 % rate for

First year .9091

Second year .8261

Third Year .7651

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Capital Budgeting Forumala