A firm can make investment in either of the following two projects. The firm anticipates its cost of capital to be 10%. The pre-tax cash flows of…

CA Intermediate · Financial Management and Strategic Management · MTP · May 2025
A firm can make investment in either of the following two projects. The firm anticipates its cost of capital to be 10%. The pre-tax cash flows of the projects for five years are as follows: Year 0 1 2 3 4 5 Project A (₹) (2,00,000) 35,000 80,000 90,000 75,000 20,000 Project B (₹) (2,00,000) 2,18,000 10,000 10,000 4,000 3,000 Ignore Taxation. An amount of 35,000 will be spent on account of sales promotion in year 3 in case of Project A. This has not been taken into account in calculation of pre-tax cash flows. The discount factors are as under: Year 0 1 2 3 4 5 PVF (10%) 1 0.91 0.83 0.75 0.68 0.62 You are required to CALCULATE for each project: (i) The Discounted Payback period (ii) Desirability factor (iii) Net Present Value

Suggested Answer and Working Notes:

Calculation of Present Value of cash flows Year PV factor @10% Project A Project B Cash flows (₹) Discounted Cash flows (₹) Cash flows (₹) Discounted Cash flows (₹) 0 1.00 (2,00,000) (2,00,000) (2,00,000) (2,00,000) 1 0.91 35,000 31,850 2,18,000 1,98,380 2 0.83 80,000 66,400 10,000 8,300 3 0.75 55,000 (90,000-35,000) 41,250 10,000 7,500 4 0.68 75,000 51,000 4,000 2,720 5 0.62 20,000 12,400 3,000 1,860 Net Present Value 2,900 18,760 (i) Discounted Payback period for the projects: Project-A: The cumulative discounted cash inflows upto year 4 is 1,90,500 and remaining amount required to equate the cash outflow is 9,500 i.e. (₹ 2,00,000 - 1,90,500) which will be recovered from year-5 cash inflow. Hence, Payback period will be calculated as below: 4 years + 9,500 12,400 = 4.766 years Or 4 years 9.19 months Or 4 years 9 months and 6 days. Project-B: The cash inflow in year-1 is 1,98,380 and remaining amount required to equate the cash outflow is 1,620 i.e. (₹ 2,00,000 - 1,98,380) which will be recovered from year-2 cash inflow. Hence, Payback period will be calculated as below: 1 year + 1,620 8,300 = 1.195 years Or 1 Year 2.34 months Or 1 Year 2 months and 10 days. (ii) Desirability factor of the projects Desirability Factor (Profitability Index) = Discounted value of Cash Inflows Discounted value of Cash Outflows Project A = 2,02,900 2,00,000 = 1.01 Project B = 2,18,760 2,00,000 = 1.09 (iii) Net Present Value (NPV) of the projects: Please refer the above table. Project A -2,900 Project B -18,760

Topics: Part-A: Financial Management

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