Management Accounting and Financial Analysis
An sw er (a) Co s t o f Pr oj oj ec ec t M
At At 15 15% I.R.R I.R.R., ., the the sum tota totall of of ca cash inflo inflow ws = Cost of of th the proje rojec ct i.e i.e.. In Initia itial cas cash outlay tlay Given: An Annual co cost sa saving ing
Rs. 40 40,00 ,000
Useful life
4 years
I.R.R.
15%
Now, considering the discount factor table @ 15% cumulative present value of cash inflows for 4 years is 2.855 Therefore, Total of cash inflows for 4 years for Project M is (Rs. 40,000 2.855) = Rs. 1,14,200 1,14,200 Hence cost of project is
= Rs. 1,14,200
Payback period of the Project M
Pay back period
Cost of the the project An Annual cost saving
Rs.1,14,200 40,000
= 2.855 or 2 years 11 months approximately Cost of Capital
If the the profitability profitabili ty index (PI) (PI) is 1, cash inflows a and nd outfl outflow ows s would would be equal. equal. In this case, (PI) is 1.064. Therefore, cash inflows inflows would would be more more by 0.64 than outflow. outflow. Profitability ity index (PI) Or 1.064
Discountedcashinflows Cost of the the project
Discountedcashinflows Rs.1,14,200
or 1.064 Rs. 1,14,200 = Rs. 1,21,509 Hence, Discounted cash inflows = Rs. 1,21,509 Since, Annual cost saving is Rs. Rs. 40,000. Hence, Hence, cumulat cumulative ive discount factor factor for 4 years years
Rs.
1,21,509 40,000
= 3.037725 or 3.038 Considering the discount factor table at discount rate of 12%, the cumulative discount factor for 4 years is 3.038. Hence, the cost of capital is 12%.
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