Page 177 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 9: Capital Budgeting

For Product A, the present value of total cash outflows is 39.366 lakhs. At the end of 3 year, the Notes
cumulative present value of cash inflows is 33.716 lakhs and for 4th year the present value of
cash inflows is 21.904 lakhs.
39.366 – 33.716
BET of Product A = 3 + = 3.26 years
21.904
For Product B
( Lakh)
Year PV Factor Cash PV of cash Cum PV of Cash PV of cash Cum. PV of
Outflows outflows cash outflows inflows inflows cash inflows.
1 0.877 10 8.77 8.77 4 3.508 3.508
2 0.769 7 5.383 14.153 32 24.608 28.116
3 0.675 17 11.475 25.628 26 17.55 45.666
4 0.592 6 3.552 29.18 8 4.736 50.402
5 0.519 0 0 29.18 2 1.038 51.44

For Product B, the present values of the total cash outflows are 29.18 1akh. At the end of 2 year,
the cumulative present value of cash inflows is 28,116 lakhs and for 3rd year the present value
of cash inflows is 17.550.
29.18 – 28.116
BET for Product B = = 2.06 years
17.550

9.4.6 BET vs. the Payback Method

Differences

1. BET starts counting time at the start of the project, irrespective of when the cash outflows
occur whereas payback method starts counting time from the initial cash outflow.

2. BET takes account of time value of money when cumulating cash inflows and cash outflows,
whereas payback method ignores the time value of money.

Similarity
1. Both methods ignore cash inflows after the break-even time or the payback period.

Self Assessment

Fill in the blanks:
8. Profitability Index will be less than I when the investment proposal has a ……………net
present value under the NPV method.
9. ‘The process of selecting the more desirable projects among many profitable investments
is called ……………………..

9.5 Financial Data for Sample Problem

From the following, calculate differential cash flow streams considering that a firm has an
existing machine and is considering the purchase of a new machine:
1. The new machine is more efficient than the existing machine. This will increase the firm’s
revenue from products made by the machine from 4,00,000 to 4,50,000 and will lower
operating cost from 2,10,000 to 1,70,000.

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