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446 Corporate Finance BRILLIANT’S

Illustration 5.1.15

The management of Manmohan Udyog has two alternative projects under consideration.
Project A requires a capital outlays of ` 3,00,000 but Project B needs ` 4,20,000. Both are estimated
to provide a cash flow for six years: A ` 80,000 per year and B ` 1,10,000 per year. The cost of
capital is 12%. Show which of the two projects is preferable from the view point of:
‘Z‘mohZ CÚmoJ Ho$ ‘¡ZoO‘|Q> Ho$ nmg Xmo d¡H$pënH$ {dMmamYrZ àmoOo³Q²>g h¢& àmoOo³Q> A H$mo < 3,00,000 Ho$ H¡${nQ>b
AmCQ>bo H$s Amdí¶H$Vm h¡ {H$ÝVw àmoOo³Q> B H$mo < 4,20,000 H$s Amdí¶H$Vm h¡& XmoZm| Ho$ 6 df© Ho$ {bE H¡$e âbmo
àXmZ H$aZo H$m AZw‘mZ h¡… A < 80,000 à{V df© VWm B < 1,10,000 à{V df©& H¡${nQ>b H$s bmJV 12% h¡& Xem©B¶o
{H$ Xmo ‘| go H$m¡Z-gm n«moOo³Q> {ZåZ{b{IV Ñ{ï>H$moU go ng§X ¶mo½¶ h¡…
(i) Net Present Value, and / ZoQ> àoO|Q> d¡ë¶y VWm
(ii) Internal Rate of Return / [aQ>Z© H$s B§Q>Z©b aoQ>
Solution:

(i) Net Present Value - Given:
Project A Project B
Cost ` 3,00,000 ` 4,20,000
Cash flows ` 80,000 ` 1,10,000
(for 6 years) Per year Per year
PVF @ 12%
Year 1 2 3 4 5 6
PVF @ 12% 0.893 0.797 0.712 0.636 0.567 0.507
Cumulative PVF for 6 years = 4.042
Project A
Discounted Cash Inflow = Cash Inflow per year (for 6 years) × Cumulative PVF @ 12%
= 80,000 × 4.112
= ` 3,28,960
NPV = Discounted Cash Inflows – Cash Outflows
= 3,28,960 – 3,00,000 = ` 28,960
Project B
Discounted Cash Inflow = Cash Outflow per year (for 6 years) × Cumulative PVF @ 12%
= 1,10,000 × 4.112
= ` 4,52,320
NPV = Discounted Cash Inflow – Cash Outflow
= 4,52,320 – 4,20,000 = ` 32,320
On the basis of NPV method, we select project B because project B having higher NPV than
project A.