Capital Budgeting Decisions By Heena Malhotra

Payback Period Traditional or Non Discounting ccounting Rat of Return (ARR) Capital Budgeting Techniques Net Present Value (NPV) Profitability Index (PI) Time adjusted or Discounted Cash Flows Internal Rate of Return (IRR) Modified Internal Rate of Return (MIRR) Discounted Payback By Heena Malhotra

Internal Rate of Return Method (IRR) IRR Definition: Internal rate of return for an investment proposal is the discount rate that equates the present value of the expected net cash flows with the initial cas outflow By Heena Malhotra

NPV PVCI - PVCo NPV- By Heena Malhotra

Acceptance Rule The use ofIRR as a criterion to accept capital investment decisioninvolves a comparison of IRR with the required rate of return known as cut off rate. The project should the accepted if IRR is greater than cut-off rate. If IRR is equal to cut off rate the firmis indifferent.I IRR less than cut off rate the project is rejected. Thus, If IRR 2 Cut-off Rate or WACC Accept the Proposal IR S Cut-off Rate or WACC Reject the Proposal By Heena Malhotra

Calculate the internal rate of return of an investment of 1,36,000 which yields the following cash inflows: Year Cash Inflows (in ) 30,000 40,000 60,000 30,000 20,000 By Heena Malhotra

Let us discount cash flows by 10% 0. Year Discounting Present Inflows (?) factor at 10% | Value (?) 0.909 0.826 0.751 0.683 0.621 30,000 40,000 60,000 30,000 20,000 27,270 33,040 45,060 20,490 12,420 Total present 1,38,280 value The present value at 10% comes to 1,38,280, which is more than the initial investment. Therefore, a higher discount rate is suggested, say, 12% By Heena Malhotra

Cash Inflows () 30,000 40,000 60,000 30,000 20,000 Year Discounting factor Present at 12% 0.893 0.797 0.712 0.636 0.567 Value (R) 26,790 31,880 42,720 19,080 11,340 1,31,810 2 3 4 Total present value By Heena Malhotra

PUGI@ -PVCo PVCI@ PVCI@h |* (HR-LR) The internal rate of return is, thus, more than 10% but less than 12%. The exact rate can be obtained by interpolation 1,38,280-71, 36,000 1,38,280-1,31,810 IRR = | 10 + x 2 10+1 44 2,280 6,470 2 |-10+0.70 IRR = 10.70% By Heena Malhotra

PVA n-1 n-1 1+i = R (PVI Fil + PVI Fi,2 + PVI Fi,3 + PWFm) R (PVIFi.n) By Heena Malhotra

A company proposes to install machine involving a capital cost of3,60,000. The life of the machine is 5 years and its salvage value at the end of the life is nil. The machine will produce the net operating income after depreciation of 68,000 per annum. The company's tax rate is 45%. The Net Present Value factors for 5 years are as under: Discounting rate Cumulative factor 14 15 1617 18 3.43 3.35 3.27 3.20 3.13 You are required to calculate the internal rate of return of the proposal. SOLUTION Computation of Cash inflow per annum Net operating income per annum Less: Tax @ 45% Profit after tax Add: Depreciation 68,000 30,600 37,400 72,000 3,60,000/5 years) Cash inflow 1,09,400 By Heena Malhotra

Computation of Internal Rate of Return 15% 3.35 3,66,490 C1,09,400x3.35) | 3,60,000 6,490 16% 3.27 3,57,738 ( 109,400x3.27) 3,60,000 2,262) Discounting Rate Cumulative factor PV of Inflows Initial outlay NPV R RR 156,490 -15+0.74 15.74%. 8752 By Heena Malhotra

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Hira najam

9 months ago

5)c.. sir in past year exams... answer of 5th question given curriculum includes both formal and informal education. plz do confirm is it right or ur one is the right ans.

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