The management of P Limited is evaluating two mutually exclusive investment alternatives, namely Machine I and Machine II, for acquisition. The…

(i) Computation of Discounted Payback Period, Net Present Value (NPV) and Internal Rate of Return (IRR) for Two Machines Calculation of Cash Inflows Machine - I (₹) Machine - II (₹) Annual Income before Tax and Depreciation 3,45,000 4,55,000 Less: Depreciation Machine - I: (₹10,00,000 / 5) 2,00,000 Machine - II: (₹15,00,000 / 6) 2,50,000 Income before Tax 1,45,000 2,05,000 Less: Tax @ 30% 43,500 61,500 Income after Tax 1,01,500 1,43,500 Add: Depreciation 2,00,000 2,50,000 Annual Cash Inflows 3,01,500 3,93,500 Present Value Factors of Re. 1 Year P.V. of Re.1 @12% P.V. of Re.1 @13% P.V. of Re.1 @14% P.V. of Re.1 @15% P.V. of Re.1 @16% 1 0.893 0.885 0.877 0.870 0.862 2 0.797 0.783 0.769 0.756 0.743 3 0.712 0.693 0.675 0.658 0.641 4 0.636 0.613 0.592 0.572 0.552 5 0.567 0.543 0.519 0.497 0.476 6 0.507 0.480 0.456 0.432 0.410 Present Value of Cash Inflows at 12% Year P.V. of Re.1 @12% Machine - I Cash flow P.V. Cumulative P.V. Machine - II Cash flow P.V. Cumulative P.V. 1 0.893 3,01,500 2,69,240 2,69,240 3,93,500 3,51,396 3,51,396 2 0.797 3,01,500 2,40,296 5,09,536 3,93,500 3,13,620 6,65,016 3 0.712 3,01,500 2,14,668 7,24,204 3,93,500 2,80,172 9,45,188 4 0.636 3,01,500 1,91,754 9,15,958 3,93,500 2,50,266 11,95,454 5 0.567 3,01,500 1,70,951 10,86,909 3,93,500 2,23,115 14,18,569 6 0.507 - - 3,93,500 1,99,505 16,18,074 Discounted Payback Period for: Machine - I Discounted Payback Period = 4 + (10,00,000 - 9,15,958) / 1,70,951 = 4 + 84,042 / 1,70,951 = 4 + 0.4916 = 4.49 years or 4 years and 5.9 months Machine - II Discounted Payback Period = 5 + (15,00,000 - 14,18,569) / 1,99,505 = 5 + 81,431 / 1,99,505 = 5 + 0.4082 = 5.41 years or 5 years and 4.9 months Net Present Value for: Machine - I NPV = ₹10,86,909 – ₹10,00,000 = ₹86,909 Machine - II NPV = ₹16,18,074 – ₹15,00,000 = ₹1,18,074 Internal Rate of Return (IRR) for: Machine - I P.V. Factor = Initial Investment / Annual Cash Inflow = 10,00,000 / 3,01,500 = 3.3167 PV factor falls between 15% and 16% Present Value of Cash inflow at 15% = 3.353 x 3,01,500 = 10,10,930 Present Value of Cash inflow at 16% = 3.274 x 3,01,500 = 9,87,111 IRR = 15 + (10,10,930 - 10,00,000) / (10,10,930 - 9,87,111) × (16-15) = 15 + 10,930 / 23,819 × 1 = 15.4588% ≈ 15.46% Machine - II P.V. Factor = Initial Investment / Annual Cash Inflow = 15,00,000 / 3,93,500 = 3.8119 Present Value of Cash inflow at 14% and 15% will be: Present Value at 14% = 3.888 x 3,93,500 = 15,29,928 Present Value at 15% = 3.785 x 3,93,500 = 14,89,398 IRR = 14 + (15,29,928 - 15,00,000) / (15,29,928 - 14,89,398) × (15-14) = 14 + 29,928 / 40,530 × 1 = 14.7384% ≈ 14.74% (ii) Advise to the Management Ranking of Machines in terms of the Three Methods Machine - I Machine - II Discounted Payback Period I II Net Present Value II I Internal Rate of Return I II Advise: Since Machine - I has better ranking than Machine - II, therefore, Machine - I should be selected.