by Capital budgeting is the process of evaluating long term investment projects to determine their profitability and feasibility. Techniques like Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index (PI) help compare expected cash inflows and outflows.
Problem 1: Net Present Value (NPV)
Data:
Initial Investment: ₹1,00,000
Expected Cash Inflows: ₹30,000 per year for 5 years
Discount Rate: 10%
Solution:
NPV = Present Value of Cash Inflows − Initial Investment
PV of inflows = 30,000 × [1 − (1 + 0.10)^-5] / 0.10
= 30,000 × 3.7908 ≈ ₹1,13,724
NPV = 1,13,724 − 1,00,000 = ₹13,724
Interpretation: Positive NPV → Project is acceptable.
Problem 2: Internal Rate of Return (IRR)
Data:
Initial Investment: ₹50,000
Cash Inflows: ₹15,000 per year for 5 years
Solution:
IRR is the rate (r) where NPV = 0
50,000 = 15,000 × [1 − (1 + r)^-5] / r
Using trial and error, r ≈ 18%
Interpretation: IRR > cost of capital → Project is acceptable.
Problem 3: Payback Period
Data:
Initial Investment: ₹80,000
Cash Inflows: ₹20,000 per year
Solution:
Payback Period = Initial Investment ÷ Annual Cash Inflows
= 80,000 ÷ 20,000 = 4 years
Interpretation: Investment is recovered in 4 years. Compare with desired payback period to decide.
Problem 4: Profitability Index (PI)
Data:
Present Value of Cash Inflows: ₹1,20,000
Initial Investment: ₹1,00,000
Solution:
PI = PV of Cash Inflows ÷ Initial Investment
= 1,20,000 ÷ 1,00,000 = 1.2
Interpretation: PI > 1 → Project is acceptable.
