Question 5.S2.EQ.3: A company has to make a choice between two projects, namely,......
A company has to make a choice between two projects, namely, A and B. The initial capital outlay of the two projects are Rs 1,35,000 and Rs 2,40,000 respectively for A and B. There will be no scrap value at the end of the life of both the projects. The opportunity cost of capital of the company is 16 per cent. The annual incomes are as under:
You are required to calculate for each project:
(i) Discounted payback period
(ii) Profitability index
(iii) Net present value
(CA—November, 2002)
| Year | Project A | Project B | Discounting factor @ 16% |
| 1 | — | Rs 60,000 | 0.862 |
| 2 | Rs 30,000 | 84,000 | 0.743 |
| 3 | 1,32,000 | 96,000 | 0.641 |
| 4 | 84,000 | 1,02,000 | 0.552 |
| 5 | 84,000 | 90,000 | 0.476 |
(i) Discounted payback period:
Project A: 3 years plus a fraction of 4th year
(Rs 1,35,000 – Rs 1,06,902 = Rs 28,098)/(Rs 1,53,270 – Rs 1,06,902 = Rs 46,368)
= 0.61 = 3.61 years
Project B: 4 years plus a fraction of 4th year
(Rs 2,40,000 – Rs 2,31,972)/(Rs 2,74,812 – Rs 2,31,972) = 0.19 = 4.19 years.
(ii) Profitability index: (PV of CFAT)/Initial cash outflows
Project A: Rs 1,93,254/Rs 1,35,000 = 1.432
Project B: Rs 2,74,812/Rs 2,40,000 = 1.145
(iii) Net present value
Project A: Rs 58,254
Project B: Rs 34, 812
Computation of net present value and discounted payback period
| Year | CFAT* | Discount factor 0.16 |
Total PV | Cumulative PV | |||
| Project A | Project B | Project A | Project B | Project A | Project B | ||
| 1 | Nil | Rs 60,000 | 0.862 | Nil | Rs 51,720 | — | Rs 51,720 |
| 2 | Rs 30,000 | 84,000 | 0.743 | Rs 22,290 | 62,412 | Rs 22,290 | 1,14,132 |
| 3 | 1,32,000 | 96,000 | 0.641 | 84,612 | 61,536 | 1,06,902 | 1,75,668 |
| 4 | 84,000 | 1,02,000 | 0.552 | 46,368 | 56,304 | 1,53,270 | 2,31,972 |
| 5 | 84,000 | 90,000 | 0.476 | 39,984 | 42,840 | 1,93,254 | 2,74,812 |
| Gross present value | 1,93,254 | 2,74,812 | |||||
| Less capital/cash outlay | 1,35,000 | 2,40,000 | |||||
| Net present value | 58,254 | 34,812 | |||||
* Annual incomes are assumed as CFAT. The reasons are: (a) method of depreciation is not given and (b) annual incomes are substantial in amount and hence assumed to be duly adjusted for depreciation.