A project of Rs.

20 lacs yielded annually

a profit of Rs.3,00,000 after
depreciation @ 12.5% and is subject to
income tax @50%.

Calculate Pay Back period.

 Calculation of Annual Cash Flow
Rs.
Profit after depreciation but before tax 3,00,000

Less :- Tax @ 50% 1,50,000

Profit After tax 1,50,000

ADD :- Depreciation ( 12.5% of Rs.20,00,000) 2,50,000

Cash Flow before depreciation & after tax 4,00,000

Pay back period = Initial Investment / Annual cash flow

= 20,00,000 /
4,00,000

= 5 years.
A company wishes to expand production has the choice of
anAutomatic machine costing Rs.21000 or a Semi Automatic
machine costing Rs.7500. The following data is available.
Particulars Automatic Semi Automatic

Annual Costs

Materials 6000 6000

Labour 1000 5000

Variable overheads 2000 1500

Estimated life 6 Years 7Years

Sales Rs.15000 P.A. Rs.15000 P.A.

Other things being equal which Machine should the co. purchase?
Asume tax rate as 50%.
 Computation of Cash Flow and Pay Back Period
Particulars Automatic M/C ( Rs.) Semi Automatic (Rs.)

Sales 15000 15000

Less :- Materials 6000 6000
labour 1000 5000
variable overheads 2000 1500
Depreciation – Auto 21000 /6 3500 -----
Semi Auto 7500 /7 ------- 12500 1071 13571
Profit before tax 2500 1429
Less :- Tax @ 50% 1250 714
Profit after tax 1250 715
Add :- Depreciation 3500 1071
Profit before Dep. and after tax 4750 1785
Pay back period = Initial Investment / Annual cash flow
= 21000 / 4750
Automatic M/c P.B.P. = 4.42 Years

Semi Automatic M / c P.B.P. = 7500 / 1785

= 4.20 years
One of the two machines A and B is to be purchased. From the following
information find out which of the two will be more profitable? The average
rate of tax may be taken at 50%
Particulars Machine A Machine B
Cost of Machine 50000 80000
Working Life 4Years 6Years
Earning before tax (After
Depreciation)

1st Year 10000 8000

2nd Year 15000 14000
3rd Year 20000 25000
4th Year 15000 30000
5th Year ----- 18000
6th year ----- 13000

Calculate Pay back period & ARR and suggest which machine the co.
should purchase?
 Computation of Pay Back period of Machine A
Year E.B.T. Tax@50% E.A.T. Cash Flow + Cum. Cash
Depreciation Flow

1 10,000 5,000 5000 17500 17500

2 15,000 7500 7500 20000 37500
3 20,000 10000 10000 22500 60000
4 15,000 7500 7500 20000 80000

Pay Back period = No. of Years completed + Bal. amount / Cash

flow for next year
= 2Years + 12,500 ( 50,000- 37,500) / 22500
= 2 years + 0.55
= 2.55 years
Average rate of Return = Average Earning / Initial Investment*100

OR = Average Earning / Average Investment *100

Average Profit = Total Profit after tax / No. of years
= 30000 / 4 = 7500
A.R.R. =7500 / 50000 *100 = 15%
 Computation of Pay Back period of Machine B
Year E.B.T. Tax@50% E.A.T. Cash Flow + Cum. Cash
Depreciation Flow

1 8000 4000 4000 17333 17333

2 14000 7000 7000 20333 37666
3 25000 12500 12500 25833 63499
4 30000 15000 15000 28333 91832
5 18000 9000 9000 22333 114165
6 13000 6500 6500 19833 133498

Pay Back Period = No. of years completed + Balance amount / Cash floe for next year

= 3 Years + 16501 ( 80,000 – 63499 ) / 28333

= 3 years + 0.58
= 3.58 years
A.R.R. = 9000 / 80000 *100
= 11.25%
Comment :- As the pay back period of Machine A is Less and A.R.R. is more as against
machine B hence Machine A is recommended.
A Chemical company is considering to invest Rs.500000 in a
project. The estimated salvage value is NIL. Tax rate is 55%.
The company uses straight line method of depreciation and
the proposed project has cash flows before depreciation and tax is as
follows.
Year 1 2 3 4 5

CFBDT (Rs.) 100000 100000 150000 150000 250000

Calculate the following

1) Pay Back Period
2) Average or Accounting rate of Return.
 Computation of Pay Back Period and Average Rate of Return
Year C.F.B.D.T. Depreciation Net Earning Tax@55% CFAT+Depr Cum Cash
eciation flow

1 1,00,000 1,00,000 ------------ ------------- 1,00,000 1,00,000

2 1,00,000 1,00,000 ------------ ------------- 1,00,000 2,00,000
3 1,50,000 1,00,000 50,000 27500 1,22500 3,22,500
4 1,50,000 1,00,000 50,000 27500 1,22500 4,45,000
5 2,50,000 1,00,000 1,50,000 82500 1,67500 6,12500

Pay Back Period = No. of years completed + Bal. amount / cash flow for next year
= 4 years + 55,000 / 1,67,500
= 4 years + 0.328
= 4.33 years
Average rate of return = Average profit / Initial Investment *100
Average profit = Total Profit after tax / No. of years
= 22500+22500+67500 / 5
= 1,12,500 / 5
= 22500
= 22500 / 5,00,000 *100
A.R.R. = 4.5%
Calculate Present value of Rs. 1 considering the discounting rate as 8%, 10% ,
12% , 15%, 20%, 25% and 30% for 5 years .

Present Value Factor = 1 / (1+r) n

where r = rate of discount
n = No. of years

Year @8% @10% @12% @15% @20% @25% @30%

1 0.926 0.909 0.893 0.870 0.833 0.800 0.769

2 0.857 0.826 0.797 0.756 0.694 0.640 0.592

3 0.794 0.751 0.712 0.657 0.578 0.512 0.455

4 0.735 0.683 0.636 0.571 0.482 0.410 0.350

5 0.681 0.621 0.568 0.496 0.402 0.328 0.269

The Alpha company ltd. Is considering the purchase of a new machine. Two alternative machines A
and B have been suggested each costing Rs.400000. Earning after taxation are expected to be as
follows.
YEAR CASH FLOW (Rs.)
Machine A Machine B
1 40000 120000
2 120000 160000
3 160000 200000
4 240000 120000
5 160000 80000

The company has a targeted return on capital of 10% and on this basis you are required to
compute Net Present Value of both the machines .State which alternative you consider
financially preferable.
The present value of Rs.1@ 10% is as under
1st year = 0.91
2nd year = 0.83
3rd year = 0.75
4th year = 0.68
5th year = 0.62
 Computation of Net Present value o Machine A and Machine B

Year Discount factor Cash Flow Present value Cash Flow Present Value
Machine A Machine A Machine B Machine B
1 0.91 40,000 36400 1,20,000 1,09,200
2 0.83 1,20,000 99,600 1,60,000 1,32,800
3 0.75 1,60,000 120000 2,00,000 1,50,000
4 0.68 2,40,000 1,63,200 1,20,000 81,600
5 0.62 1,60,000 99200 80,000 49600
Total Present value ( Rs.) 518400 5,23,200

Total Present Value 5,18,400 5,23,200

Less :- Initial Investment 4,00,000 4,00,000
Net Present Value ( N.P.V.) 1,18,400 1,23,200

Comment :- As the Net Present value of Machine B is more than Machine A hence
Machine B is recommended.
Suresh Engineering Ltd. Is considering two investments each of
which requires an initial investment of Rs.180000. The total cash
inflow i.e. profit after taxes and depreciation charges for each
project are as as under.
YEAR Project (A) Project B (Rs)
(RS).
1 30000 60000
2 50000 100000
3 60000 65000
4 65000 45000
5 40000 ------
6 30000 ------
7 16000 ------

The cost of capital is 8%.. Calculate Net Present Value &

suggest which project is more profitable.
 Computation of Net Present value in respect of Project A and Project B

Year PV factor Project A Cash Present Value Project B Cash Present value
Flow Project A Flow Project B
1 0.926 30000 27780 60000 55560
2 0.857 50000 42850 100000 85700
3 0.794 60000 47640 65000 51610
4 0.735 65000 47775 45000 33075
5 0.681 40000 27240 ------------ --------------
6 0.630 30000 18900 ------------ ---------------
7 0.583 16000 9328 ------------ ----------------
Total Present Value 221513 225945
Less :- Initial Investment
180000 180000
Net Present Value 41513 45945

As The NPV of Project B is Higher than project A it is recommended.

 Internal Rate of Return (I.R.R.)
The Internal Rate of Return method considers the Time
value of Money, Initial Investment and all cash flows
from initial investments.

But unlike the Net Present Value method the Internal

Rate of Return method does not use the desired rate of
return but estimates the discount rate that makes the
present value of subsequent net cash flows equal to the
initial investment.

This discount rate is called as I.R.R.

Formula for Internal Rate of Return

I.R.R. = LR + NPV at LR
* ( HR – LR)
NPV at LR - NPV at HR

Where LR = Lower Rate

HR = Higher Rate
A firm whose cost of capital is 10% considering two mutually exclusive projects X
and Y. The details of which are as under.

Year Project X (Rs.) Project Y (Rs.)

Investment 70000 70000
Cash Flow
1st year 10000 50000
2nd year 20000 40000
3rd year 30000 20000
4th year 45000 10000
5th year 60000 10000

Compute the following

1) Net present value @10%
2) Profitability Index
3) Internal rate of return
Computation of Net Present Value and profitability Index of Project X &Y

Year PV Factor Project X Cash Present value Project Y Cash Present Value
@10% Flow Flow
1 0.909 10,000 9,090 50,000 45,450
2 0.826 20,000 16,520 40,000 33,040
3 0.751 30,000 22,530 20,000 15,020
4 0.683 45,000 30,735 10,000 6,830
5 0.621 60,000 37,260 10,000 6,210
Total Present Value 1,16,135 1,06,550
Less :- Initial Investment 70,000 70,000
Net Present Value ( N.P.V.) 46,135 36,550

Profitability Index = P.V. Of cash Inflows / P.V. of cash outflows

= 1,16135 / 70,000 =
1,06,550 / 70,000
= 1.659 =

1.522
 Internal Rate of Return for Project X

Year P.V. factor Cash Flow P.V. of Cash P.V. Factor P.V. of cash
@25% Flow @30% Flow

1 .800 10,000 8,000 0.769 7,690

2 .640 20,000 12,800 0.592 11,840
3 .512 30,000 15,360 0.455 13,650
4 .410 45,000 18,450 0.350 15,750
5 .328 60,000 19,680 0.269 16,140
Total Present value 74,290 65,070
Less :- Initial Investment 70,000 70,000
Net Present Value + 4,290 - 4930

= NPV 25%at+ LR
4290 / 4290 – ( - 4930) * ( 30-25)
I.R.R. = LR + = 25%+ 4290* ( HR/ 9220
– LR) * 5
= 25%
NPV + 2.326
at LR - NPV=at27.326%
HR
 Internal Rate of Return for Project Y

Year P.V. factor Cash Flow P.V. of Cash P.V. Factor P.V. of cash
@35% Flow @40% Flow

1 0.741 50,000 37,050 0.714 35,700

2 0.549 40,000 21,960 0.510 20,400
3 0.407 20,000 8,140 0.364 7,280
4 0.301 10,000 3,010 0.260 2,600
5 0.223 10,000 2,230 0.186 1,860
Total Present value 72,390 67,840
Less :- Initial Investment 70,000 70,000
Net Present Value + 2,390 - 2,160

I.R.R. = LR + NPV at LR
* ( HR – LR)
NPV at LR - NPV at HR

= 35% + 2390 / 2390 – ( - 2160) * ( 40-35)

= 35% + 2390 / 4,550 * 5
= 35% + 2.626
= 37.626 %
A company proposes to install a machine involving a
capital cost of Rs.360000.
The life of the machine is 5 years & its salvage value at
the end of the life is Nil.
The machine will produce the net operating income after
depreciation rs.68000 p.a.
The company’s tax rate is 45% the cost of capital is
15%
Calculate the following
1) Net Present value
2) Profitability Index
3) Discounted Pay back period
4) Internal rate of return
 Computation of Net Present Value and profitability Index
Year EBT or Tax@45 PAT Depreciat Cash PV Presen Cum
PBT % ion Inflow Factor t Present v
value
1 68000 30600 37400 72000 109400 0.870 95178 95178
2 68000 30600 37400 72000 109400 0.756 82706 177884
3 68000 30600 37400 72000 109400 0.657 71876 249760
4 68000 30600 37400 72000 109400 0.571 62467 312227
5 68000 30600 37400 72000 109400 0.496 54262 366489

1) Net Present Value = Total Present Value - Initial Investment

= 366489 - 360000
= Rs.6489
2) Profitability Index = P.V. of Cash inflow / P.V. of Cash Outflow
= 366489 / 360000
= 1.018
3) Discounted pay back period = No. of years completed + Bal. Amount / Cash flow next year
= 4 years + ( 360000 – 312227) / 54262
= 4 years + 47773 / 54262
= 4 years + 0.880
= 4.88 years
 Computation of Internal Rate of Return

Year PV Factor Cash Inflow Present Value PV factor Present Value

@15% @20%

1 0.870 109400 95178 0.833 91130

2 0.756 109400 82706 0.694 75924
3 0.657 109400 71876 0.578 63233
4 0.571 109400 62467 0.482 52731
5 0.496 109400 54262 0.402 43979
Total Present Value 366489 326997
Less :- Initial Investment 360000 360000
Net Present Value +6489 - 33003

I.R.R. = LR + NPV at LR
* ( HR – LR)
NPV at LR - NPV at HR
= 15 % + 6489 / 6489 - (-33003) * ( 20 – 15)
= 15% + 6489 / 39492 * 5
= 15% + 0. .822
= 15.822%
A company has to make a choice between 2 projects A&B The initial outlay of
the two projects are Rs.135000 & Rws.240000 respectively with no scrap
value. The cost of capital is 16%. The cash inflows are as follows.

Year 1 2 3 4 5

A Nil 30000 132000 84000 84000

B 60000 84000 96000 102000 90000

Calculate for each project

1) Pay Back period
2) Discounted pay back period
3) Net Present value
4) Profitability Index
 Computation of Net Present Value and profitability Index and Discounted Pay Back Period

Year EAT Or Depreciati Cash Cumulativ PV Present Cum

1 PAT 2 on 3 Inflow e Cash Factor value Present
4 Inflow 5 6 (4*6) 7 value
8

1 Nil 27000 27000 27000 0.862 23274 23274

2 30000 27000 57000 84000 0.743 42351 65625
3 132000 27000 159000 243000 0.640 101760 167385
4 84000 27000 111000 354000 0.552 61272 228657
5 84000 27000 111000 465000 0.476 52836 281493

1) Pay Back Period A = No. of years completed + Balance amount/ Cash Flow for next year
= 2 years + ( 135000 – 84000) / 159000
= 2 years + 0.321 = 2.321 Years
2) Discounted Pay back period = 2 years + ( 135000 – 65625) / 101760
= 2 years + 0.682 = 2.682 years
3) Net Present value (A) = Present value of cash Inflows – Initial Investment
= Rs.281493 – 135000
= Rs. 146493
4) Profitability Index A = P.V. of Cash Inflows / P.V. of Cash outflows
= 281493 / 135000
= 2.085
 Computation of Net Present Value and profitability Index and Discounted Pay Back Period

Year EAT Or Depreciati Cash Cumulativ PV Present Cum

1 PAT 2 on 3 Inflow e Cash Factor value Present
4 Inflow 5 6 (4*6) 7 value
8

1 60000 48000 108000 108000 0.862 93096 93096

2 84000 48000 132000 240000 0.743 98076 191172
3 96000 48000 144000 384000 0.640 92160 283332
4 102000 48000 150000 534000 0.552 82800 366132
5 90000 48000 138000 672000 0.476 65688 431820

1) Pay Back Period B = No. of years completed + Balance amount/ Cash Flow for next year
= 1 year + ( 240000 – 108000) / 132000
= 1year + 1year = 2.0 Years
2) Discounted Pay back period = 2 years + ( 240000 – 191172) / 92160
= 2 years + 0.530 = 2.530 years
3) Net Present value (B) = Present value of cash Inflows – Initial Investment
= Rs.431820 – 240000
= Rs. 191820
4) Profitability Index B = P.V. of Cash Inflows / P.V. of Cash outflows
= 431820 / 240000
= 1.799
 A company is considering two mutually exclusive projects X & Y details of which are
as follows.

Particulars X Y
Cost of Project 1000000 1000000
Cash Inflows /
Year
1 100000 500000
2 200000 400000
3 300000 200000
4 450000 100000
5 600000 100000

Assume scrap value at the end is Nil. The cost of capital is 10%.
Calculate the following
1) Pay Back Period
2) Discounted pay back period
3) Net Present Value
4) Internal Rate of Return
5) Profitability Index
Computation of Net Present Value and profitability Index and Discounted Pay Back Period

Year EAT Or Depreciati Cash Cumulativ PV Present Cum

1 PAT 2 on 3 Inflow e Cash Factor value Present
4 Inflow 5 6 (4*6) 7 value
8

1 100000 200000 300000 300000 0.909 272700 272700

2 200000 200000 400000 700000 0.826 330400 603100
3 300000 200000 500000 1200000 0.751 375500 978600
4 450000 200000 650000 1850000 0.683 443950 1422550
5 600000 200000 800000 2650000 0.621 496800 1919350

1) Pay Back Period X = No. of years completed + Balance amount/ Cash Flow for next year
= 2years + (1000000– 700000) / 500000
= 2years + 0.60 year = 2.60 Years
2) Discounted Pay back period = 3 years + ( 1000000 – 978600) / 443950
= 2 years + 0.0482 = 2.0482 years
3) Net Present value (X) = Present value of cash Inflows – Initial Investment
= Rs.1919350- 1000000
= Rs. 919350
4) Profitability Index X = P.V. of Cash Inflows / P.V. of Cash outflows
= 1919350 / 1000000
= 1.919
Computation of Net Present Value and profitability Index and Discounted Pay Back Period
Year EAT Or Depreciati Cash Cumulativ PV Present Cum
1 PAT 2 on 3 Inflow e Cash Factor value Present
4 Inflow 5 6 (4*6) 7 value
8
1 500000 200000 700000 700000 0.909 636300 636300
2 400000 200000 600000 1300000 0.826 495600 1131900
3 200000 200000 400000 1700000 0.751 300400 1432300
4 100000 200000 300000 2000000 0.683 204900 1637200
5 100000 200000 300000 2300000 0.621 186300 1823500

1) Pay Back Period Y = No. of years completed + Balance amount/ Cash Flow for next year
= 1years+ (1000000– 700000) /600000
= 1year + 0.50 year = 1.50 Years
2) Discounted Pay back period = 1 year + ( 1000000 – 636300) / 495600
= 1years+ 0.734 = 1.734 years
3) Net Present value (Y) = Present value of cash Inflows – Initial Investment
= Rs.1823500- 1000000
= Rs. 823500
4) Profitability Index Y = P.V. of Cash Inflows / P.V. of Cash outflows
= 1823500 / 1000000
= 1. 823
 Computation of Internal Rate of Return of X

Year PV Factor @ Cash Inflow Present Value PV factor Present Value

35% @40%

1 0.741 300000 222300 0.714 214200

2 0.549 400000 219600 0.510 204000
3 0.407 500000 203500 0.364 182000
4 0.301 650000 195650 0.260 169000
5 0.223 800000 178400 0.186 148800
Total Present Value 10,19,450 918000
Less :- Initial Investment 10,00,000 10,00,000
Net Present Value + 19,450 - 82,000

I.R.R. X = LR + NPV at LR
* ( HR – LR) NPV at LR - NPV at HR
= 35% + 19,450 / 19450 – ( -82,000) / (40-35)
= 35% + 19450 / 101450 * 5
= 35% + 0.959
= 35.959%
 Computation of Internal Rate of Return of Y

Year PV Factor @ Cash Inflow Present Value PV factor Present Value

45% @50%
1 0.690 700000 483000 0.667 466900
2 0.476 600000 285600 0.445 267000
3 0.328 400000 131200 0.297 118800
4 0.226 300000 67800 0.198 59400
5 0.156 300000 46800 0.132 39600
Total Present Value 1014400 951700
Less :- Initial Investment 10,00,000 10,00,000
Net Present Value + 14,400 - 48,300

I.R.R. X = LR + NPV at LR
* ( HR – LR)
NPV at LR - NPV at HR

= 40% + 14,400 / 14,400 – ( -48300) / (50-45)

= 40% + 14,400 / 62700* 5
= 40% + 1.148
= 41.148%